Capital Gains Tax Exemptions - Long & Short Term Overview

Capital gains refer to the profit realized from the sale of capital assets like shares, bonds, and real estate, among other investments. These capital gains are taxed depending upon several factors including the holding period of the asset and the individual’s tax bracket. However, there are certain exemptions and deductions available that can help an individual reduce the tax liability on capital gains. Understanding capital gains exemption can be crucial for investors and traders looking to optimize their investment strategy and maximize their returns.

Based on the holding period of the asset, capital gains are classified as short-term capital gains and long-term capital gains. Let us first understand what are short-term capital gains and long-term capital gains.

What is Short-Term Capital Gain (STCG)?

The gains made by selling an asset after holding it for less than 36 months are short-term capital gains. For immovable properties or assets like land or building, the holding period to calculate short-term capital gains is 24 months.

Meanwhile, gains earned from the sale of assets, such as shares listed on stock exchanges, after holding them for less than 12 months, are treated as short-term capital gains.

Short-term capital gains are added to the individual’s taxable income and taxed as per their income tax slab rate. The current applicable tax rate for short-term capital gains on the sale of listed securities is 15% if the transaction is subject to Securities Transaction Tax (STT). However, if the transaction is not subject to STT, the short-term capital gains tax rate is the same as the taxpayer’s applicable income tax slab rate.

Taxpayers can reduce their tax liability by offsetting their short-term capital gains with short-term capital losses in the same financial year or carry forward the loss for up to eight years to set off against future capital gains. Additionally, taxpayers can also claim deductions under various sections of the Income Tax Act to reduce their overall tax liability.

What is Long-Term Capital Gain (LTCG)?

Long-term capital gains are the profit earned from the sale of assets after holding them for 36 months. It is usually the gains made over a long holding period. However, the holding period differs for various assets.

For assets such as equities and equity-oriented mutual funds, the holding period to determine long-term capital gains is 12 months, while for debt mutual funds, it is more than 36 months. For movable and immovable properties, the period is more than 36 months and 24 months, respectively.

The long-term capital gains are taxed at 20% with indexation benefits. Meanwhile, gains of more than Rs 1 lakh are taxed at 10% without indexation. Indexation allows adjusting the cost of acquisition for inflation, which reduces the tax liability. Individuals can claim long-term capital gains exemption to reduce their tax liability.

Exemptions Available Under Capital Gains

Exemptions under Capital Gains refer to specific transactions or investments that are not subject to tax on the gains realized. Individuals can avail of various exemptions under capital gains tax to protect their income from the sale of capital assets and ultimately reduce their overall tax liability. These capital gains exemptions come with certain conditions. Here are some of the tax exemptions available on capital gains tax:

Capital Gains Exemption Under Section 54

The capital gains earned from the sale of a property will be tax-exempted if the gains are reinvested to purchase another property. However, the tax exemption will only apply if the following conditions are met: 

• The gains from the sale of the property are used to purchase the second property within one year of ownership transfer or two years of the property sale.

• If the second property purchased is under construction, the property sale should be completed within three years of the initial property sale.

• The newly acquired property should be in India and cannot be sold within three years of purchase.

Capital Gains Exemption Under Section 54EC

Under Section 54EC of the Income Tax Act, individuals can claim tax exemption if capital gains from the sale of immovable property are invested in capital gain bonds or 54EC bonds. These are fixed-income instruments that offer capital gains tax exemption under section 54EC to the investors.

The capital gains bonds are issued by the government infrastructure companies and are redeemable before maturity. The bonds eligible under this section include Rural Electrification Corporation Limited (REC) bonds, Power Finance Corporation Limited (PFC) bonds, National Highway Authority of India (NHAI) bonds, and Indian Railway Finance Corporation Limited or (IRFC) bonds.

This tax exemption is subject to the following conditions:

• The investment in the bonds should be made within six months of the property sale.

• The bond investment cannot be redeemed within five years of investment.

• Under this section, a maximum amount of Rs 50 lakh can be claimed for tax exemption.

Capital Gains Exemption Under Section 54F

When the capital gains are earned from any long-term capital asset, except residential property, you can claim a tax exemption under Section 54F. This tax deduction is subject to the following conditions: 

• The asset is bought within two years of earning the capital gains.

• The asset acquired should not be sold within three years of the purchase or completion of construction.

• If the asset purchased is under construction, it must be completed within three years from the date of sale.

The Income Tax Act provides various exemptions for capital gains arising from the sale of assets such as property, shares, and mutual funds. These exemptions are subject to specific conditions and may require reinvestment in specified assets or within a specified period. Taxpayers can also reduce their tax liability by offsetting their capital gains with capital losses in the same financial year or carry forward the loss for up to eight years to set off against future capital gains. It is essential for taxpayers to stay updated with the latest tax laws and understand the capital gains exemptions understand to optimize the tax planning strategy.