How To Benefit From The Rs 1 Lakh Deduction Limit On Long Term Capital Gains

Every taxpayer has to ensure that they make the best use of the various deductions and exemptions that are available to them. The taxation of capital gains has meant that they need to plan the gains in such a manner that they are able to restrict the burden that falls on them.

One of the ways in which the benefit can be taken is to make full use of the Rs 1 lakh deduction for long term capital gains, as this can save some amount of tax over the long run as compared to a situation where this is not used.

Investing in stocks and equity oriented mutual funds is useful for long term wealth building. One of the best ways to build wealth is to stay invested for a long time period and ensure compounding of the money. Since April 2018, the tax treatment has changed and long term capital gains has been brought within the ambit of tax (earlier there was no tax on long term capital gains), and now there is a 10% tax rate on such gains, while the tax rate on short term capital gains is 15%. While investors would do well to build wealth by long term holdings, there is a benefit available of Rs 1 lakh deduction each year and to use this, it needs some planning.

There should be effective tax planning for the individual, such that they do not let the Rs 1 lakh limit go to waste in any year. Every investor will have a portfolio of holdings and there can be a situation where they are able to sell some equity mutual fund units, or shares in such a way that they book at least Rs 1 lakh of long term capital gains. The important point here is that its not the value of sale which has to be Rs 1 lakh, but the long term capital gains should be Rs 1 lakh, since only amounts above this figure is taxable. This, in simple words, will lead to savings of Rs 10,000 of tax (plus cess) every year. 

Often it might happen that if the investor sells their long term holdings in equities or equity oriented mutual fund, only when the money is required or the goals are met, then there could be several years in between when there might not be any long term capital gain. This would lead to the loss of the tax free benefit. To simplify the understanding, consider a situation where an investor holds an investment in the portfolio for a period of five years and then books a capital gain of Rs 10 lakh, then they would have to pay a tax of Rs 90,000, which is 10% of the gains. (Total gains Rs 10 lakh less Rs 1 lakh deduction = 9 lakh X 10%). The situation here is such that the investor has missed out on the Rs 1 lakh deduction in the interim period.

On the other hand, if the investor ends up booking Rs 1 lakh of gain for the next four years and then selling the investment in the fifth year, then they would get a final tax impact of Rs 50,000. (Rs 6 lakh – Rs 1 lakh deduction = Rs 5 lakh X 10%). This is a reduction of the tax liability by Rs 40,000. In many cases it might not be possible and practical for the investor to book long term capital gains from the same security every year, but they can do this using some other equity oriented mutual fund, or equity shares to achieve the same tax saving.

There are some additional conditions that need to be met by the investor when they are using this benefit. If there is a long term loss during the year, then this benefit would not be available, though the loss can be carried forward. If there is a long term capital loss carried forward from earlier times, then these will be used to set off the long term capital gains and only if some gains remain, they would be taxable.

Also, they need to ensure that their long term investing process is not disturbed. This means that they need to put back or reinvest the amount that they have received through the sale in the investment again. This will ensure that the compounding benefit is not lost out. Otherwise, if the sale amount is used for some other purpose and not reinvested, it could affect the overall wealth building process. The investor needs to look carefully at their portfolio holdings and then decide which investment should be used for booking the capital gain. A distinction between short term capital gains and long term capital gains has to be made as this benefit is available on the latter, where the holding period must be more than 12 months.

In addition, if there is an amount reinvested, then this should also be held for 12 months, so that on sale it will qualify for the 10% long term rate, otherwise the tax liability will be higher at 15% if the reinvested amount is sold earlier. 

Arnav Pandya is founder Moneyeduschool

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.