Long-Term Capital Gain vs. Short-Term Capital Gain: A Beginner's Guide

Long-Term Capital Gain vs. Short-Term Capital Gain: A Beginner's Guide

 Introduction

Capital gains refer to the profit realized when an asset is sold at a higher price than its purchase price. It's a crucial concept for any individual or entity involved in investments. The Income Tax Act of 1961 in India categorizes capital gains into two primary types: Long-Term Capital Gain (LTCG) and Short-Term Capital Gain (STCG). This article aims to demystify these terms for beginners.

Understanding Capital Assets

Before delving into the gains, it's essential to comprehend what constitutes a capital asset. As per the Income Tax Act, a capital asset is any property, including:

• Immovable property
• Movable property
• Jewellery
• Shares, securities, bonds
• Vehicles
• Copyrights, patents, trademarks
• Any other property not specifically excluded

However, there are exceptions, such as items used for personal use, stock-in-trade, and inventory held for business purposes.

Short-Term Capital Gain (STCG)

When a capital asset is held for a specific period and then sold, the profit earned is termed a Short-Term Capital Gain. The holding period for determining STCG varies based on the asset type:

• Equity shares and units of equity-oriented funds: If held for less than or equal to 12 months.
• All other assets: If held for less than or equal to 24 months.

STCG is generally taxed at a higher rate compared to LTCG. The tax rate depends on the assessee's income slab and other applicable factors.

Long-Term Capital Gain (LTCG)

If a capital asset is held for a period longer than the specified holding period (12 months for equity shares and units of equity-oriented funds, 24 months for other assets), any profit realized upon sale is considered LTCG.

India has introduced preferential tax rates for LTCG to encourage long-term investments.

LTCG on Equity Shares and Units of Equity-Oriented Funds

• Indexation Benefit: LTCG from the sale of equity shares or units of equity-oriented funds held for more than 12 months is eligible for indexation benefits. Indexation adjusts the purchase price for inflation, reducing the taxable gain.
• Tax Rate: After considering indexation, the LTCG is taxed at a concessional rate of 10% for gains exceeding Rs. 1 lakh in a financial year.

LTCG on Other Assets

• Indexation Benefit: LTCG from the sale of other assets (like real estate, gold, etc.) held for more than 24 months is also eligible for indexation.
• Tax Rate: The LTCG on such assets is generally taxed at a flat rate of 20% after indexation.

Impact of Cryptocurrency on Capital Gains

Cryptocurrencies like Bitcoin have gained significant popularity. The Income Tax Department has clarified that virtual digital assets, including cryptocurrency, are considered capital assets.

• Short-term Capital Gain: If held for less than or equal to 12 months, the profit from the sale of cryptocurrency is treated as STCG and taxed as per the income tax slab.
• Long-term Capital Gain: If held for more than 12 months, the profit is considered LTCG and taxed at a flat rate of 30% without indexation benefits.

Computation of Capital Gains

Calculating capital gains involves determining the cost of acquisition, improvement expenses, and sale proceeds. Indexation benefits, if applicable, are also considered. The net gain is then subjected to the appropriate tax rate.

Exemptions and Deductions

There are certain exemptions and deductions available for capital gains. These include:

• Cost Inflation Index (CII): Used for indexation to adjust the purchase price for inflation.
• Long-Term Capital Gains from Equity Shares: Part of the LTCG can be claimed as a deduction under Section 112A of the Income Tax Act.
• Losses: Capital losses can be offset against capital gains in the same year or carried forward for eight assessment years.

Conclusion

Understanding the nuances of long-term and short-term capital gains is crucial for effective tax planning. While LTCG generally offers tax benefits, the holding period and asset type play a significant role. It's advisable to consult with a tax professional for personalized guidance based on your specific investment portfolio.

Let's Continue: Examples and FAQs on Capital Gains

Examples of Long-Term and Short-Term Capital Gains

Example 1: Equity Shares

• Mr. Sharma purchases 100 shares of XYZ Ltd. on April 1, 2022, for Rs. 100 per share.
• On April 1, 2023, he sells all the shares for Rs. 150 per share.
• Since the holding period is less than 12 months, the profit of Rs. 5,000 per share (Rs. 150 - Rs. 100) is considered Short-Term Capital Gain.

Example 2: Real Estate

• Ms. Patel purchases a residential property on April 1, 2020, for Rs. 50 lakhs.
• On April 1, 2023, she sells the property for Rs. 80 lakhs.
• Since the holding period is more than 24 months, the profit of Rs. 30 lakhs is considered Long-Term Capital Gain eligible for indexation benefits.

Frequently Asked Questions (FAQs)

1. What happens if I incur a capital loss?

   • Capital losses can be offset against capital gains in the same year. Any unabsorbed loss can be carried forward for eight assessment years.

2. Is there any difference in taxation for individuals and companies?

   • Yes, the tax rates and treatment of capital gains differ for individuals and companies. Companies are generally subject to higher tax rates.

3. How does the cost inflation index affect capital gains?

   • The CII is used to adjust the purchase price of assets for inflation. A higher CII reduces the taxable capital gain.

4. What is the impact of gift tax on capital gains?

   • If you receive a capital asset as a gift, the cost of acquisition for you is the market value of the asset on the date of gift. Any subsequent gain on sale will be subject to capital gains tax.

5. Are there any exemptions for agricultural land?

   • Yes, capital gains from the sale of agricultural land are generally exempt from tax, subject to certain conditions.

Conclusion

Understanding the intricacies of long-term and short-term capital gains is essential for effective tax planning. By carefully analyzing the holding period, asset type, and applicable tax rates, individuals and businesses can optimize their tax liabilities. It's advisable to seek professional advice to ensure compliance with tax laws and maximize tax benefits.