What is Capital Gain? Short term and Long term capital gain explained

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The profit an individual receives through the sale of an asset like stocks, bonds, or real estate is known as a capital gain. When the selling price of an asset exceeds its purchase price will result in capital gain.

The gain earned on the sale of the aforementioned assets is taxable and falls under the income category. So, it is mandatory for an individual to pay the tax for that capital gain amount in the year in which the transfer of the capital asset takes place. The tax that needs to be paid is called capital gains tax and it can either be long term or short term.

As per the Income Tax Act, in India, one need not pay the capital gains tax if there are no sales of the assets. However, if the person who has inherited the property decides to sell it, the tax will have to be paid on the income that has been generated from the sale.

Types of capital gains
The capital gains can be of two types

  1. Realised capital gain: It can be described as the gain made on an investment that has been sold for a profit.
  2. Unrealised capital gain: It can be described as the gain on an investment that has not been sold yet but can make a profit if sold later.

Know about Short-Term and Long-Term Capital Gains:
As aforementioned the capital gains occurs only when an individual sell a capital asset over and above its cost of purchase and the tax that one must pay on the profits they have made from selling these notified capital assets is known as capital gain tax.

The total capital gains earned by a taxpayer for the year need to be reported while filling their annual tax returns because the respective authorities will treat these capital gains earnings as taxable income.

As per the law, Capital gains have been divided into two categories, namely:
● Long Term Capital Gains (LTCG)
● Short Term Capital Gains (STCG)

Long Term Capital Gains (LTCG)
In case, if an owner sells an asset after 24 months (2 years) from the date of purchase the profit earned are included under long term gains. From the FY 2017-18, the criteria of 36 months have been reduced to 24 months for immovable properties such as land, building and house property.

The movable properties such as jewellery, debt-oriented mutual funds, etc are not included under the reduced period of 24 months. They will be classified as a long-term capital asset only if held for more than 36 months as earlier.

Long-term capital gains are subject to a 20% tax rate, plus applicable cess and surcharge. LTCG’s tax rate is reduced to 10% if the taxpayers’ meet specific eligibility criteria or have made such gains from below mentioned transactions:
● Selling shares
● Unit Trust of India (UTI), whether quoted or not.
● Mutual funds, or
● Zero-coupon bonds

The afforementioned assets are considered as long term assets if they are held for a duration of more than 12 months.

Short Term Capital Gains (STCG)
If an owner of capital assets, sells them within 24 months (2 years) from the date of purchase after having profits, then short-term capital gains are made. The short-term capital gains are subject to section 111A and are taxed at 15%, plus applicable cess and surcharge.

It must be noted that the gains which are not covered by section 111A will be taxed at slab rates applicable to an individual’s total taxable income. On the basis of Individual’s tax bracket, this might go up to 37 percent.

Long and short-term capital gains tax – Pros and cons
The capital gains taxes are very different from income taxes, and both long-term and short-term gains provides and benefits. However, there are few drawbacks which needs to be aware of.

Pros
● Capital gains taxes needs to be paid only if you actually sell an investment.
● The tax rates for long-term capital gains are preferential. As, Investors who buy and hold are rewarded with significantly lower tax rates on their gains, which add up the savings

Cons
● The capital gains cut into your return on investment.
● A perverse incentive will be provided on the lower tax rate for long-term capital gains to hold investments for too long.