LONG TERM CAPITAL GAIN

What is capital gain?

When you sell any asset you own (house, land, shares, mutual fund units, gold,
debentures, bonds) and you make a profit on the sale, it is known as capital gain.
The tax you pay on this profit is called the capital gains tax.

If you make a loss (you sell at a lower price than you bought it), you incur a
capital loss.

What are the types of capital gains?

Depending on how long you held the asset, the capital gain is classified either as
short-term or long-term.

Short-term capital gain: If you sell the asset within 36 months from the date of
purchase (12 months for shares or mutual funds)

Long-term capital gain: If you sell the asset after 36 months from the date of
purchase (12 months for shares or mutual funds)

How is short-term capital gain taxed?

Very simple. A short-term capital gain is added to your total income. Depending
on which tax bracket you fall under, you will be taxed.

How is long-term capital gain taxed?

Tax on long-term capital gain (other than shares and mutual fund units), is more
complicated. This is because inflation is taken into account. This is good because
it reduces the amount of capital gain and the amount you end up paying as tax.

Let's say Mr Mani 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

= Buying cost x CII
= 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)

How is long-term capital gain taxed on shares and mutual funds?

You can pay the tax on long term capital gains on shares and mutual funds either
at the rate of 20% or 10%. The choice is yours.

This is how it is done.

Let's say that Mr Mani purchased 4,000 shares on July 27, 2003 and paid Rs 10
per share. He sold them on September 15, 2004 for Rs 12 per share.

Since the investment is held for more than 12 months, the capital gain will be
long-term.

If he computes with indexation using the above method, his capital gain will
amount to Rs 6,532.

He will have to pay a tax of 20% on Rs 6532, which is Rs 1,306.

If he computes without indexation, this is the way it is done.

Sale proceeds = Rs 48,000 (4,000 shares x Rs 12)

Cost of acquisition = Rs 40,000 (4,000 shares x Rs 10)
Long-term capital gain = Rs 8,000
Tax payable will be 10% on Rs 8,000, which is Rs 800

Has the capital gain calculation not changed in the case of shares?

Yes. From October 1, 2004, if you sell your shares, equity mutual funds and
balanced mutual funds which have an equity component of 50% or more, the
computation of tax differs.

If you have a short-term capital gain, the tax will be chargeable at 10%.

A long-term capital gain is not taxed.

On the flip side, no longer can you carry forward your long-term capital loss.

Long-Term Capital Gains Definition

Long-term capital gains are investments that are held for 12 months or longer and then
sold. Long-term capital gains are common with long-term investors and are seen as a
positive because these investments are in a lower tax bracket.
Long-term capital gains Formula

Remember this formula is applicable to securities that have a minimum holding period of
12 months.

Long-term capital gains = Purchase Value - Current Asset Value

Long-term capital gains Tax Brackets

The government places a lower tax bracket on long-term investments as an incentive for
investors to take a more disciplined approach to growing wealth. Below are the capital
gains tax brackets for 2007. Please note these numbers will adjust depending on the
outcome of the 2008 U.S. Presidential Election.

1. 5% for taxpayers in the 10% and 15% tax brackets

2. 15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets

Long-Term Capital Gains Example

Let's say that an investor purchased $100,000 worth of stock in the year 2002. The
investor saw the market tanking during the 2008 credit crisis and was now ready to sell.
The investor initially purchased the stock at $25 per share and the stock is now worth
$40. This means the trader would have made $60,000 ($15 profit per share * 4,000
shares). This means that the investor now has a long-term capital gains tax responsibility
for $60,000. Let's assume this investor is in the 33% tax bracket and will be responsible
for the 15% tax on the gains. So, in this example, the investor would be responsible for
$9,000 ($60,000 * 15%). Hence the traders after tax income would be $51,000.

Tax Planning opportunities for Long term capital gains

Sec 54 EC
Under this sec if an assessee earns LTCG then he will not be require to pay any tax if he
is investing the entire LTCG in specified securities within 6 months from the date of
transfer.

The specified securities are:

1. Bonds of NHAI (National Highway authority of India)

2. REC Bonds (Rural electrification corporation Ltd)