Capital gains are the profits / losses that arise when you sell a capital asset. That includes equities, bonds, property, gold etc. Each asset has a different definition of long term and short term capital gains. For example, in case of equity the definition is 1 year, for property it is 2 years and for gold and bonds it is 3 years. The most important aspect is how to manage capital gains. Capital gains can be managed, it can be reduced and it can also be saved. Here are some important ways to manage capital gains.
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How to effectively save capital gains?
When we focus on saving of capital gains, we shall focus largely on the long term gains. In case of short term gains, which we shall deal with briefly, there is only the write off and the carry forward. There are a lot more options in case of long term gains.
Short term gain tax can be reduced by writing off any short term loss against such gains. Remember, short term capital losses can be written off against short term gains and also against long term capital gains.
Short term gains can also be carried forward for a period of 8 assessment years subsequent to the year in which the loss was made. However, such carry forward will not be permitted if the tax returns for the said year were not filed on time and before the due date of July 31st, which is normally the case.
The stocks which are in loss can be made good use to reduce tax outgo. Sell the loss-making stocks and book loss.Â Adjust this loss against capital gains and reduce the tax on capital gains from stocks.Â This is called Tax Loss Harvesting.
Long term capital losses can be written off against only long term capital gains. Such losses cannot be written off against short term gains. Capital gains as a header cannot be written off against any other head of income but only against capital gains.
Long term losses on equities were not eligible for tax shield in the past as the LTCG on equities was tax free. However, with the LTCG being made taxable from April 2018 onwards, such losses can be set off against gains. However, in such cases the returns have to be filed on time before the due date.
Section 54 is an interesting section available if you want to avoid paying long term capital gains tax on the sale of property. If such capital gains is reinvested in another property within 1 year before the sale date or 2 years after the sale date, then such capital gains shall be fully exempted. However, such reinvested property will have to be held for a minimum period of 3 years.
In case of realty gains and other long term gains, there is an additional Section 54EC that is also available if the proceeds of the sale are reinvested in specified infrastructure bonds issued by the government authorized infrastructure institutions like IREDA, REC, and NHAI etc. Such bonds normally entail a lock in period of at least 7 years and in such cases, the interest received on such bonds is fully taxable in the hands of the investor.
Phasing investments is another way of saving tax on long term capital gains on equity and equity funds. This can be done in two ways. Firstly, since the Income Tax Act offers a rebate of Rs.1 lakh each financial year for LTCG, the selling of equity or equity funds can be spread in such a way that the LTCG is realized gradually over time. Secondly, in case of equity funds, one can also opt for the systematic withdrawal plan (SWP), wherein the entire corpus is written down over a long time period such that each withdrawal is a mix of return and principal withdrawal; making the entire process more tax efficient.
Lastly, there is the benefit of double indexation that one can use to reduce capital gains. What is double indexation? When you buy assets, you run the inflation risk over time. Hence charging you capital gains tax on the original cost may be unfair. Hence the Income Tax Department issues the index numbers each year based on inflation. Based on this index number, you can index the cost of acquisition and pay much lower tax. Double indexation is all about timing the entry and exit in such a way as to minimize your tax outgo. For example, if you invest in a fixed maturity plan on 29th March 2015 and exit the FMP on 2nd April 2018, then you have actually held the FMP for 3 years and 5 days but because your FMP straddles four financial years, you get that additional benefit of indexation for 1 more year.
The Income Tax Act has in-built methods of capital gains through a lot many legitimate methods. The onus is on you how best you make use of these provisions.
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