How to Calculate Capital Gains and What is Indexation?

In this post we will learn How to calculate Capital Gains or Losses . A lot of people make mistake in this . If you buy a house in 1995 at Rs 10 lacs and sell it at Rs 20 lacs in 2009 . On how much profit will you pay the tax ? If your answer is Rs 10 lacs , you have no idea how to calculate capital gains . Read ahead to understand .

What is Capital Asset ?

Capital Assets are the properties which can be held by a person . Some examples are Real Estate, Shares Mutual Funds, Gold and Debt Funds. FD’s and other fixed returns Instruments are not part of it.

How to Calculate Capital Gains?

Most of the people think that

Capital Gain = Sell Price – Purchase Price 

But , Actually the real formula is

Capital Gain = Sell Price – Indexed Purchase Price

What is Indexation ?

Indexation is a technique to adjust income payments by means of a price Index , in order to maintain the purchasing power of the public after inflation. We must understand that prices in general also rises, so the actual prices should not be used while computing the profits , rather It should be Indexed as per Inflation in the country ,so that people can get the real value from sale of there assets . Indexation is used in Tax treatment for Debt , Gold and other asset classes

What is Cost Inflation Index (CII)?

Year	CPI
1981-82	100
1982-83	109
1983-84	116
1984-85	125
1985-86	133
1986-87	140
1987-88	150
1988-89	161
1989-90	172
1990-91	182
1991-92	199
1992-93	223
1993-94	244
1994-95	259
1995-96	281
1996-97	305
1997-98	331
1998-99	351
1999-00	389
2000-01	406
2001-02	426
2002-03	447
2003-04	463
2004-05	480
2005-06	497
2006-07	519
2007-08	551
2008-09	582
2009-10	632
2010-11	711
2011-12	785
2012-13	852
2013-14	939
2014-15	1024

How to Calculate Indexed Purchase Price ?

Indexed Purchase Price = Purchase Price * (CPI for current year / CPI for year of purchase)

Once you have Indexed Purchase Price , you can subtract it from Sale Price and get your capital gains .

In some products Long term Capital gains is around 20% with Indexation and 10% without Indexation . In Equities Long term Capital Gains is exempt from Tax .

Let take an Example

Purchase Price	1000000
Year of Purchase	1995
Sale Price	2500000
Year of Sale	2008
No of Years	13
Purchase CII	281
Sale CII	582
Indexed Purchase Price	2071174
Capital Gain	428826
Tax with Indexation	85765
Tax without Indexation	150000

  

I hope the above example is clear. Below is the calculator I have created for you to calculate Capital Gain tax for yourself. Just play with different numbers. Just enter the year of Purchase and Sale and It will figure out the CII (incase it does not, please put CII yourself)

Capital Gains Calculator

Download Capital Gain Tax CalculatorHere

Capital Gains Tax with Indexation and Without Indexation

There are some asset classes where you have the choice of using Indexation or not. This is true for debt funds and FMP’s. So the current rate is either 20% with Indexation or 10% without Indexation for Long term Capital Gains.

For Tax without Indexation, you simply find out normal profit (sale price – cost price) and then calculate the tax .

So you can calculate tax using both ways and then choose the one which is lower .

How to save your Capital Gains Tax?

For people who are miser and do not like to pay lot of taxes, govt has provided some relief to them. Govt. says that If you don’t want to pay tax on your capital gains, you can do following things to save your taxes.

Invest your Capital Gains in Real Estate: If you invest your Capital Gains in Real estate within 2 yrs , you will get the exemption.

Invest in Capital Gain Bonds: There are some specific bonds issued under sec 54EC , some of them are NHAI or REC bonds . You have to invest in these bonds within 6 months. Generally the lock in period is around 3+ yrs. Interest on NHAI or REC bonds is around 5-5.5% .

Tax on Capital Gains can be different for different People

Please note that Capital Gains tax can vary from one person to other person depending on which tax bracket he/she belongs to . It will also depends whether Tax with Indexation or without Indexation works out to be cheaper for him or not.

Note :For calculation purpose the Financial years are business year from April – Mar , Not Jan – Dec . If you buy in June 2009 and sell in Jan 2010 , you are in the same year not 2 different years

Conclusion
So, In this post we learned how you can calculate capital gains and also take advantage of tax benefits for saving your taxes on capital gains , Your aim should be to understand the process and learn about it, so that you can take informed decisions in your financial life . No one should take advantage of your ignorance and also to take quick decisions and make rough calculations when there is a need. If you know these rules, you can take better decisions