Investment School: What is Capital Gain tax?

### What is Capital Gain tax?

Tax is one area where most of us have always loads n loads of questions. One major tax that is associated with any individual who owns an asset is Capital gains tax.

What is Capital Gains?

When a person sells an asset and makes profit out of it, the profit is called Capital Gains. The tax paid on profit of these asset sale is Capital Gains Tax. The asset may include
mutual funds, stocks, house, land,gold and few other. When a person makes a loss out of his asset sale, it is called Capital Loss.

What are 2 types of Capital Gains?

Depending on how long you hold on to your asset before selling, there are two types of capital gains.

Short Term Capital Gains

If a person sells an asset before 3 years from its purchase and if he makes a profit , it is called short term capital gains tax. For mutual funds and equities, it is 1 year.

Long Term Capital Gains

If a person sells an asset after 3 years from its purchase and makes a profit, it is called as a long term capital gains tax. For mutual funds and shares, it is 1 year.

Short Term Capital Gains Tax:

The short term capital gains is added to your taxable income for the financial year and taxed at your income tax slab rate.

Long Term Capital Gains Tax:

There are two ways for taxing long term gains.

1. 10% of your gains without indexation.
2. 20% of your gains with indexation.

Lets take an example for case 2 (with indexation)

Let's say Mr Ram purchased a house of Rs 2,50,000 (Rs 250,000) on June 20, 1996. He sells it on January 20, 2005, for Rs 4,50,000 (Rs 450,000). Since the house was sold over 36 months after being bought, the capital gain will be long term.

First, you calculate the Cost Inflation Index. These indices are fixed and declared by the Central Government every year (see table below). This is called indexation.

Cost inflation index:

Index of the year it was sold / index of the year it was bought
2004-05 index / 1996-97 index
480/305 = 1.57377

Indexed cost of acquisition

= 250000 x 1.57377
= 3,93,443

Long term capital gain

= Selling price – Indexed cost
= 4,50,000 – 3,93,443
= Rs 56,547

Tax payable will be 20% of Rs 56,547 ie Rs 11,310. (Plus surcharge of 10% if applicable)