Capital Gain Tax – A Complete Guide
Taxes on the profit realized from the sale of non-inventory assets such as stocks and bonds are known as capital gains taxes (CGTs).
In the midst of making investment decisions, it’s easy to forget about the unavoidable tax consequences—especially capital gains tax. It’s hard enough to pick the right stock or mutual fund without worrying about after-tax profits. However, for day traders and others who take advantage of online trading’s convenience, it’s important to remember that there are consequences.
For other investments, such as your home, tax considerations must be taken into account. If you’re going to get the most out of your investments, you need to factor in taxes and how you buy and sell. In this article, we’ll take a closer look at the capital gains tax and what you can do to reduce it.
Overview on Capital Gain Tax (CGT)
Taxes on the profit realized from the sale of non-inventory assets such as stocks and bonds are known as capital gains taxes (CGTs). Stocks, bonds, jewelry, real estate, and property are the most common sources of capital gains.
A capital gain or loss is simply the profit or loss that occurs when a capital asset is transferred. Capital gains can be generated by selling long-term or short-term assets depending on how long they have been held. There is a capital loss if the result of selling is negative. In the year of the transfer of capital assets, the capital gain will be taxed.
What is Capital Gain Tax (CGT)?
An individual’s profit from the sale of a capital asset is referred to as a capital gain. ‘Income from Capital Gains’ taxes the profit made from the sale of a capital asset. Selling the asset for a higher price than what you paid for it is how you make a profit. The inherited property is exempt from capital gains tax because there is only one transfer of ownership and no sale. The Online Income Tax Act 1961 completely exempts any asset received as a gift by will or inheritance. A person who inherits an asset and then decides to sell it will be subject to capital gains tax (CGT).
Understanding Capital Assets
A capital asset is any type of property that you own, whether or not it is related to your business or profession. An asset is defined as any tangible or intangible asset that can be moved or immovable. The following are some examples of Capital Assets: Home, jewelry, land, vehicles, building, a patent, trademark, goodwill, rights, and machinery.
However, the following assets are excluded from the definition of capital assets:
- Stock in trade
- Raw materials and consumables that are used for commercial or professional purposes.
- Anything you own that you use on a regular basis such as clothing or furniture.
- Agricultural lands that are not located within:
- The municipality or cantonment board has a population between 10,000 and 100,000.
- Between 100,000 and 1,000,000 people live within six kilometers of the municipality or cantonment board.
- Over 110,000 people live within eight kilometers of the municipality or cantonment board.
- Government of India’s Gold Bonds, Special Bearer Bonds, and Gold Deposit Bonds.
Types of capital assets
Capital gains tax is the tax that is levied on the profits made from the sale of a capital asset. Short-term and long-term capital assets are the two most common types of capital assets.
Long term capital assets
Assets that are held for more than 36 months are considered long-term capital assets. Mutual funds, jewelry, and other investments that are held for more than 36 months fall into this category, and the 24-month reduction period does not apply under these circumstances.
If the assets listed below are held for more than a year, they are considered long-term assets:
- Bonds with no interest payments.
- Units of the UTI Trust.
- Units of stock-based mutual funds.
- Securities that are traded on an Indian stock exchange such as
- Government securities, bonds, and debentures.
- Preference shares or equities held in a company that is listed on an
- Indian stock exchange.
Short term capital assets
Assets that are held for less than 36 months qualify as short-term capital assets. From FY 2017-18, the criteria for immovable properties like land, buildings, and houses have been reduced from 36 months to 24 months. After holding the property for 24 months, any income resulting from the sale will be considered long-term capital gain if the property is sold before March 31, 2017. Ordinary income taxes are levied on short-term capital gains. All income from short-term investments must be counted toward your taxable income for the year in which they were held.
Difference between long term capital gain tax rates and short term capital gain tax rates
Long-term capital gains are realized when an asset is held for more than a year before it is sold. There are three tax rates for long-term capital gains: 0 percent, 15 percent, and 20 percent, depending on the amount of income you make. Most long-term capital gains are taxed at a rate of 15% or less.
When you sell an asset that you’ve owned for less than a year, you’ve realized a short-term capital gain. Short-term gains are taxed according to the marginal income tax bracket in which you fall. There are currently seven federal tax brackets in the United States, with rates ranging from 10% to 37%.
Calculation of capital gain tax
Capital Gains are calculated differently depending on how long an asset has been held. Individuals should be aware of the following considerations when calculating capital gains:
Terms you should know before calculating capital gain tax
There are three important terms you need to know on how to calculate capital gain tax:
- Full value consideration – The amount of money that the seller will receive as a result of the transfer of the property. Even if the funds were not received in the year of the transaction, capital gains are taxed in the year in which they were earned.
- Cost of acquisition – The price paid by a buyer to acquire a piece of property.
- Cost of improvement – Any costs incurred by the seller as a result of any renovations or additions to the property should be taken into consideration. Any changes made prior to April 1, 2001 are not eligible for consideration.
Calculate long term capital gain tax rate
Capital Gains for long-term investments are calculated as follows:
- The individual must first assess the asset’s full value.
- The individual must make the following deductions:
- Expenses incurred as a result of the transfer.
- The amount of money spent on acquiring the property.
- Costs associated with making improvements.
Section 54B, Section 54F, Section 54EC, and Section 54 exemptions must be subtracted from the total that was arrived at by performing the calculations mentioned above.
Example of calculation
An example of how to calculate long-term capital gains is shown below:
- The house was bought for Rs. 35 lakh.
- Purchasing the house occurred during the 2011-2012 fiscal year.
- The house was sold for the following fiscal year: 2019-2020.
- The price of the house: Rs.60 lakh
- Its adjusted cost: (289/184) x 35 = 54.97 lakhs in inflationary terms
- Capital Gains: 60 lakh – 54.97 lakh = 503,000 in the long term (approx)
Calculate short term capital gain tax rate
In order to calculate short-term capital gains, individuals must follow the following steps:
Before anything else, the individual must take into account the property’s total worth. Next, the following points must be taken into consideration:
- There have been costs associated with the property’s improvement.
- Amount spent on the acquisition of the property.
- Any costs associated with the transfer of the property.
- The short-term capital gain is calculated by subtracting the deduction from the total.
Example of calculation
The following is an illustration of how short-term capital gains are calculated:
- Rs.55 lakh was the selling price of the property.
- Brokerage, commissions, and other fees: Rs.30,000
- Consideration for the sale: Rs.54,70,000
- The cost of the house: Rs. 35 lakh.
- Sum spent on home improvements: Rs.3 lakh.
- Rs.16,70,000 in short-term capital gains
- Sections 54, 54B, 54D, 54EC, 54ED, 54F, and 54G provide zero tax breaks.
- Rs. 16,70,000 in net short-term capital gains
- Short-Term Capital Gains: 30 percent of Rs.1,670,000: Rs.501,000
Tips to reduce capital gain tax
The capital gains tax effectively reduces the investment’s total return. There is a legitimate way to reduce or even eliminate their net capital gains taxes for the year for some investors. Listed below are some of the simplest strategies to minimize capital gain tax.
Have capital losses exceed capital gains
Capital losses can be used to offset capital gains and reduce capital gains tax for the year. Then, what if the losses outweigh the gains?
There are two options available to you. You can deduct up to $3,000 from your income if your losses exceed your gains. It is possible to deduct any excess loss that is not used in the current year from your income to lower your future tax bill.
As an illustration, let’s say an investor sells some stocks for a profit of $5,000 but loses $20,000 in the process. It is possible to use the capital loss to offset the $5,000 gain in taxes. The remaining $15,000 in capital losses can then be used to reduce taxable income.
To put it another way, an investor who makes $50,000 per year can report $50,000 less than the maximum annual claim of $3,000. That brings the total taxable income to $47,000. After four years, the investor still has $12,000 in capital losses and can deduct $3,000 per year.
Don’t break the wash sale rule
Think twice before reinvesting in the same investment when selling the stock at a loss to take advantage of a tax break. Wash-sale rules prohibit such a sequence of transactions if they are completed within 30 days.
Tax advantage retirement plan
There are many benefits to retirement plans, including the fact that your investments can grow without being taxed on the capital gains they generate. The funds in most plans are not subject to taxation until the plan participant withdraws them. Taxes are levied on withdrawals regardless of the value of the underlying asset. The lower your tax bracket, the more money you can take out of your retirement account. As a result, your savings will have grown tax-free.
Sell assets after retirement
As you near retirement, consider delaying the sale of profitable assets until you can no longer earn a living. If your retirement income is low enough, you may be able to get a break on capital gains taxes. For those who don’t want to pay any capital gains tax at all, this may be possible.
In a nutshell, think about the consequences of taking the tax hit while you’re still employed rather than when you’re retired. If you’re already in a low or no-paying tax bracket, recognizing the gain sooner could cause you to owe more in taxes.
Consider right Holding period
Selling security must occur at least one year and one day after the purchase date in order to be treated as a long-term capital gain on your tax return. Check the actual trade date of the purchase if you’re selling a security you bought over a year ago.
If you can wait a few days, you might be able to avoid being taxed on it as a short-term capital gain. Of course, these timing maneuvers are more important in large trades than in smaller ones. If you’re in a higher tax bracket, the same rules apply to you.
Pick the right basics
In most cases, investors use the first-in, first-out (FIFO) method to calculate the cost basis when they buy and sell shares of the same company or mutual fund at different times. Last, in first-out (LIFO), dollar value LIFO, the average cost for mutual fund shares, and specific share identification are all other options available.
In order to make the best decision, consider the basis price of the purchased shares or units, as well as the amount of profit that will be declared. It may be necessary to seek the advice of a tax professional in more complicated situations. It can be difficult to calculate a company’s cost basis. You will need to use an online broker to access your account statements. Any way you slice it, make sure you’ve got accurate records.
Lost records or confirmation statements can make finding out when a stock was purchased and at what price an absolute nightmare. It can be difficult to determine exactly how much money you made or lost when selling a stock, so it’s important to keep track of your statements. Those dates are required for Schedule D.
Need help with managing your capital gain tax?
It is important to take taxes into consideration when developing an investment strategy. Eqvista can help you maximize your capital gain tax savings. Our expert team will help to value your assets and business. For more information, please don’t hesitate to contact us. We will be happy to help!