Understanding capital gains tax can be challenging, especially for small business owners juggling multiple responsibilities. However, delving into this topic can provide valuable insights. By examining the intricacies of capital gains tax step by step and incorporating real-life examples, we can gain a comprehensive understanding of this subject. Additionally, we will explore the methods for calculating capital gains tax and delve into the various long-term capital gain tax exemptions available.
What are Capital Assets?
Capital assets are essentially properties you own that can be transferred. They encompass various items, from physical property to investments and even some intangible assets.
Types of Capital Assets
- Real Estate: Land, buildings, and residential properties.
- Investments: Shares, bonds, mutual funds, and other financial instruments.
- Collectables: Art, antiques, and rare coins.
- Intangible Assets: Patents, trademarks, and goodwill.
- Machinery and Vehicles: Business equipment, machinery, and vehicles used for business purposes.
However, not everything you own qualifies as a capital asset. Here are some items that do not fall under this category:
- Inventory and Raw Materials: Items held for business use or consumption.
- Personal Belongings: Items like clothes, furniture, and other personal use items.
- Agricultural Land: Specifically, agricultural land is located in rural areas.
- Certain Bonds: Special bearer bonds, 6.5% gold bonds (1977), 7% gold bonds (1980), national defence gold bonds (1980), and gold deposit bonds (1999) issued under specific schemes.
Short Term vs Long Term Capital Gains
It’s crucial to understand the disparity between short-term and long-term capital gains tax. Short-term capital gains tax applies to assets sold within a year, usually taxed at a higher rate comparable to ordinary income. On the other hand, long-term capital gains tax is levied on assets held for longer periods and often incurs a lower tax rate, encouraging long-term investments. In India, the tax rate for equities is 10% for long-term gains exceeding ₹1 lakh in a fiscal year, while for other assets such as real estate or gold, the rate is 20%, with the benefit of indexation. This nuanced understanding is essential for making informed investment decisions, as it significantly affects the post-tax profit on investments.
How to Calculate Capital Gains Tax
To understand how to calculate capital gains tax, let’s use a capital gains tax calculator. The basic steps are:
- Determine the sale value
- Calculate the acquisition cost: The original amount paid for the asset.
- Find the indexed acquisition cost: This adjusts the purchase price for inflation, especially important for long-term assets.
- Compute the capital gain: Subtract the indexed cost from the sale value.
- Calculate the tax: Apply the relevant tax rate to your capital gain.
Understanding these steps will help you calculate capital gains tax effectively. Let’s break this down with a hypothetical example. Consider a scenario where you purchased a residential plot for ₹ 10 lakhs a decade ago and recently sold it for ₹ 25 lakhs. To calculate the long-term capital gains tax, you would need to take the following steps:
- Sell Value: ₹ 25 lakhs
- Cost of Acquisition: ₹ 10 lakhs
- Indexation Factor: 2.5 (Assuming for the ten years)
- Indexed Cost of Acquisition: ₹ 10 lakhs * 2.5
= ₹ 25 lakhs
- Capital Gain: Selling Price – Indexed Cost
= ₹ 25 lakhs (selling price) – ₹ 25 lakhs (indexed cost)
= ₹ 0 (After indexation, there is no taxable gain)
Considering this example, there is no taxable gain after factoring in inflation. However, if the plot had been sold for a sum of ₹ 30 lakhs, the capital gain would be ₹ 5 lakhs, resulting in a tax of 20% on the gain, which amounts to ₹ 1 lakh.
Long-Term Capital Gain Tax Exemption
Let’s delve into the topic of tax exemptions on long-term capital gains. There exist various legitimate methods to minimize or completely erase your tax obligations.
Section 54 Exemption
If you sell a residential property and reinvest the capital gain in another residential property within a specified period, you can claim a tax exemption. For instance, if you sell a house for ₹ 50 lakhs and make a profit of ₹ 20 lakhs, you won’t have to pay long-term capital gains tax if you buy another property within two years for at least ₹ 20 lakhs.
Section 54F Exemption
It is similar to Section 54 but applies to assets other than residential property. If you sell a plot of land and use the sale proceeds to buy a house, you can claim a full exemption on the capital gains.
Saving Tax on Long-Term Capital Gains
Bonds Investment:
Utilize Section 54EC to invest in bonds issued by the National Highways Authority of India (NHAI) or Rural Electrification Corporation (REC) to save taxes on long-term capital gains. You can invest up to ₹ 50 lakhs in these bonds.
Capital Gains Account Scheme:
If you are not immediately reinvesting your capital gains in another property, consider depositing the money in a Capital Gains Account Scheme. For example, if Priya sells a piece of land for Rs. 30 lakhs, making a profit of Rs. 15 lakhs, instead of paying the long-term capital gains tax immediately, she invests Rs. 15 lakhs in NHAI bonds within six months. This way, she defers the tax and earns interest on the bonds.
Let’s take an example to understand better how one can save taxes by holding their investment for a long period.
Example: Raj, the owner of a small business, invested in stocks a few years ago. When his business required quick capital, he chose to sell these stocks. Despite initial worries about tax implications, Raj found that he had held the stocks for over three years after using a capital gains tax calculator. Consequently, the tax rate was only 10% on profits exceeding Rs. 1 lakh. With gains of Rs. 2 lakhs, he realized that the tax payable was just Rs. 10,000. Relieved, Raj used the remaining funds to expand his business.
Also Read: Fundamental Changes In The Income Tax Return Forms AY 2024-25
Conclusion
Understanding capital gains tax can seem daunting, especially for small business owners balancing various responsibilities. However, delving into this topic can provide valuable insights. By examining the intricacies of capital gains tax step by step and incorporating real-life examples, we can gain a comprehensive understanding of this subject. Additionally, we will explore the methods for calculating capital gains tax and delve into the various long-term capital gain tax exemptions available.
Remember that knowledge is power. The more we understand about capital gains tax, the better equipped we are to make informed decisions and navigate the financial landscape. While you are optimizing your financial strategy, consider streamlining your business operations as well. Subscribe to Captainbiz GST billing software for your business today. Start a 14-day free trial. No payment is required.
Frequently Asked Questions (FAQs)
Is capital gain added to taxable income?
No, capital gains are taxed under the Capital Gains head and not added to general taxable income.
How do I avoid capital gains tax on my property?
Invest in another property, NHAI/REC bonds, or use the Capital Gains Account Scheme under Sections 54, 54EC, and 54F.
Do I have to pay capital gains tax if my total income is less than ₹ 2.5 lakh?
No, if your total income including capital gains is below Rs. 2.5 lakh, no tax is levied.
What are the best ways to avoid capital gains tax?
Invest gains in specified government schemes, buy new property, or invest in bonds as specified by the CBDT.