We take a look at how capital gains and losses are arrived at for the purpose of taxation.
Any asset you own constitutes what is called ‘capital.’ So when you sell off an asset, the difference between the buying price and selling price is what is called a capital gain or loss. When the selling price exceeds the buying price, it is a capital gain. And if the selling price falls short of the buying price, it is a capital loss. When you make a gain, it is considered an income which is then subject to income tax. And when you make a loss, you can use the shortfall as a deduction against any other income you may have made during the year, hence reducing your overall tax liability. The nature of the sale of an asset in itself is considered an extraordinary circumstance. So the report of the sale of the asset is required to be mentioned separately as a transaction when you are filing your income tax return.
Short Term Capital Vs. Long Term Capital
For the purpose of taxation, capital has been classified into two types: short-term capital and long-term capital. As the name suggests, the determination of the category is done by assessing the period for which the asset has been held. Usually, assets held for a period of less than a year are considered short-term capital. And assets held for a period longer than a year are considered long-term capital. This rule doesn’t apply to all assets as a blanket rule. Like all rules, there are exceptions to this one as well. Stocks and shares fall under this one-year rule. But land can be held for a period of two years and still fall under the category of short-term capital gains. Gold can be held for a period of three years before it is taxed in the category of long-term capital gains. So calculating the tax liability capital gains or losses is not as simple as just calculating the difference between the buying price and the selling price.
Calculating the Taxation On Capital Gains
Capital losses are, of course, not taxed and can be used as deductions against income from other sources to reduce your overall tax liability. Capital gains on the other hand are liable to income taxes. And not only is the holding period different for different assets. Even the tax rate differs for different assets. The sale of shares and stocks that fall under the category of short-term capital gains are taxed at 15%. Gains from the sale of any other asset that falls under the category of short-term capital gains are added to the other income made during the year and taxed as per the slab rate of that particular assessment year.
Long-term capital gains are also bifurcated into similar categories. The sale of stocks and shares that fall under the category of long-term capital gains are taxed at a rate of 10%. But if the gain is less than ₹1 lakh, then it is exempt from tax. But gain from the sale of any other asset other than stocks and shares that falls under the category of long-term capital gains is taxed at a flat rate of 20%.
Another thing to be considered when it comes to capital gains or losses, especially long-term capital gains or losses, is the concept of indexation. Given that time is an important factor in determining the nature of the capital gain or loss, we also have to account for the change in the economic atmosphere as far as long-term capital gains are considered. The buying price has to be adjusted for the cost of inflation before deducting it from the sale consideration to arrive at the capital gain or loss.
For this, you refer to something called a cost Inflation Index or CII, which is a value issued by the income tax department every year by evaluating the change in the cost of living in general. First, you take the CII of the year in which the asset has been sold and divide it by the CII of the year in which the asset was purchased. Next, you multiply this value by the purchase price of the asset. This enhanced cost is what you call the indexed cost’ which is what is considered for the purpose of arriving at the capital gain or loss.
Income Tax Return
Depending on your income and your status, a different income tax return is applicable. For individuals, any income from sources other than business or profession has to be reported in a form called ITR-2. The important information that this form asks for is the date of purchase of the asset, the purchase amount of the asset, the date of sale of the asset, the sale consideration of the asset and any expenses you may have incurred on the sale of the asset such as registration charges or stamp duty.
The calculation of the capital gain or loss can significantly impact the overall calculation of your taxable income and consequently your tax liability. Given that there are so many stipulations when calculating your tax liability makes it all the more critical to make sure that you have verified all the rules and checked all the right boxes in your tax return. If you have sold or are planning on selling any of your capital assets, get in touch with us so we can find you the best expert assistance in calculating your capital gains or losses as well as filing your tax returns.