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Capital gains on shares and mutual funds: how the tax is actually computed
Holding period decides the rate, the fund category decides the holding period, and the broker statement rarely decides anything correctly. Here is how to compute gains you can defend.
Investors usually pay the wrong amount of capital gains tax for one of three reasons: they use the broker profit-and-loss statement as if it were a tax computation, they misclassify a hybrid or international fund, or they forget that losses have rules of their own. Each of those is avoidable in an afternoon.
Holding period decides everything else #
Before you look at a rate, classify the asset and count the days. The classification drives the holding period, the holding period drives whether the gain is short or long term, and only then does a rate apply.
| Asset | Long term after | Notes |
|---|---|---|
| Listed equity shares and equity mutual funds | 12 months | Securities transaction tax must have been paid on the transaction |
| Unlisted shares | 24 months | Includes shares held before an IPO |
| Immovable property | 24 months | Counted from the date of registration, not of booking |
| Debt and most non-equity funds | Per the rules applicable to the year of purchase and sale | The treatment of debt funds has changed by purchase date — check the vintage of the units |
| Gold, jewellery and physical assets | Per the applicable schedule for the year | Keep purchase invoices; valuation reports are a weak substitute |
Rates and periods have been amended more than once in recent years. Confirm the position for the specific financial year of sale rather than reusing last year working file.
Grandfathering on pre-2018 equity #
For listed equity and equity funds bought before 1 February 2018, the cost for long term gain purposes is the higher of the actual cost and the fair market value as on 31 January 2018, capped at the sale value. In practice this protects the gain accumulated up to that date.
Broker statements frequently apply this incorrectly for bonus and split-adjusted holdings. If a holding predates 2018 and has been through a corporate action, recompute it manually and keep the working.
A worked example #
Take a portfolio with four transactions in one year.
| Transaction | Held | Result | Treatment |
|---|---|---|---|
| Listed shares, bought 2019, sold this year | Over 12 months | Gain 3,20,000 | Long term equity |
| Equity fund, bought and sold this year | 7 months | Loss 40,000 | Short term capital loss |
| Equity fund switch between plans | 18 months | Gain 60,000 | Redemption — long term, even though no money left the fund house |
| Unlisted shares of a private company | 30 months | Gain 1,50,000 | Long term, different rate track |
The short term loss is set off first against short term gains, and then against long term gains; the balance is carried forward. The switch is the entry investors miss most often, because no bank credit appears against it.
Setting off and carrying forward losses #
The rules are narrow and worth memorising.
- A short term capital loss can be set off against both short term and long term capital gains.
- A long term capital loss can be set off only against long term capital gains.
- Capital losses cannot be set off against salary or business income.
- Unabsorbed capital losses carry forward for eight assessment years — but only if the return was filed within the due date.
That last condition costs people real money every year. A late return does not merely attract a fee; it can extinguish a carry-forward worth far more.
Exemptions worth planning for #
On property, Section 54 and Section 54F allow reinvestment in a residential house within the prescribed windows, with the capital gains account scheme available where the money cannot be deployed before the filing date. Section 54EC permits investment in specified bonds within six months, subject to the annual cap.
These are planning provisions, not filing provisions. Deciding in July to claim an exemption for a sale made in the previous December usually means the deadline has already gone.
Documents to keep for eight years #
Keep contract notes, registrar capital gains statements, demat transaction statements, corporate action records for bonus and split events, the 31 January 2018 valuation working for older holdings, sale deeds with stamp duty valuations, and proof of any reinvestment claimed. Scrutiny of a capital gains schedule is a documents exercise; nothing else persuades.
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