Capital Gains Exemption

The sale of a capital asset often results in a capital gain, which is taxable under the Income Tax Act. However, to minimize this tax burden, the law provides several capital gains exemptions and deductions. Taxpayers can reduce their tax liability by planning their investments in accordance with the relief options available. This article explains the various capital gains exemptions that individuals and entities can claim to optimize tax savings.

The purpose of these exemptions is to encourage taxpayers to reinvest their capital gains into new capital assets within a prescribed time frame. When such reinvestments are made as per the specified conditions, the taxpayer becomes eligible for a deduction equivalent to the amount invested in the new asset, subject to section-specific rules.

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What are Short-Term Capital Gains?

Short-term capital gains (STCG) are determined based on the holding period of the asset. Identifying whether an asset is short-term or long-term is essential since the applicable tax rate varies accordingly. The table below outlines the nature of assets, their holding period, and the applicable tax rates before and after July 23, 2024.

Particulars	Up to 22nd July 2024		From 23rd July 2024
	Period of Holding	Tax Rate	Period of Holding	Tax Rate
1. Listed Equity Shares or Equity Mutual Funds	Less than 1 year	15%	Less than 1 year	20%
2. Land or Building, Unlisted Equity Shares	Less than 2 years	As per slab rates	Less than 2 years	As per slab rates
3. Other Capital Assets	Less than 3 years	As per slab rates	Less than 2 years	As per slab rates
4. Specified Mutual Funds (Debt Mutual Funds)*	N/A	As per slab rates	N/A	As per slab rates

What are Long-Term Capital Gains?

Long-term capital gains (LTCG) are determined based on the holding period of a capital asset. The classification of an asset as short-term or long-term is crucial since the tax rates differ for each category. The following table outlines the nature of assets, their holding period, and the applicable tax rates before and after July 23, 2024.

Particulars	Up to 22nd July 2024		From 23rd July 2024
	Period of Holding	Tax Rate	Period of Holding	Tax Rate
1. Listed Equity Shares or Equity Mutual Funds	More than 1 year	10% (on gains exceeding ₹1,00,000)	More than 1 year	12.5% (on gains exceeding ₹1,25,000)
2. Land or Building, Unlisted Equity Shares	More than 2 years	20% with indexation benefits	More than 2 years	12.5% without indexation benefits**
3. Other Capital Assets	More than 3 years	20% with indexation benefits	More than 2 years	12.5% without indexation benefits*

Specified mutual funds with less than 35% exposure in Indian listed equity fall under this category. These funds will be taxed as short-term capital gains, regardless of the holding period.

From July 23, 2024, the tax rate on long-term capital gains for other assets has been reduced from 20% to 12.5%, but the indexation benefit has been withdrawn. However, taxpayers selling real estate purchased before July 23, 2024 can choose between two options — pay 12.5% without indexation or 20% with indexation, depending on which is more beneficial.

In the following sections, we will examine the section-wise deductions available under the Income Tax Act and the conditions that must be met to qualify for these long-term capital gains exemptions.

Exemptions Available for Capital Gains

When it comes to capital gains exemptions, several questions arise — who can claim the deduction, how much exemption is available, what type of asset must be sold, what kind of new asset must be purchased, and within what time frame. The details below explain these aspects clearly:

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Section 54 – Profit on Sale of Residential Property

Eligible Assessee: Individual / Hindu Undivided Family (HUF)
Type of Asset Transferred: Residential House Property
Nature of Transfer: Long-Term Capital Asset
Type of New Asset to be Purchased: Residential House Property

Time Limit for Investment:

• Purchase within 1 year before or 2 years after the date of transfer, or
• Construct a new house within 3 years from the date of transfer

Exemption Amount:

• Lower of: Long-Term Capital Gain (LTCG) or Cost of the New Residential Property

Capital Gains Account Scheme (CGAS):

• Applicable – The unutilized amount of capital gain must be deposited in a CGAS account before the due date of filing the return.

Additional Conditions:

• If the newly purchased or constructed property is sold within 3 years, the amount previously claimed as exemption will be deducted from its cost of acquisition (COA) while computing future capital gains.
• If the deposited amount under CGAS is not utilized within the prescribed period, it will become taxable as capital gains in the year when the period expires.

 

Section 54B – Capital Gain on Transfer of Agricultural Land

Eligible Assessee: Individual / Hindu Undivided Family (HUF)

Type of Asset Transferred:
Land used for agricultural purposes by the individual, their parents, or the HUF for a minimum of two years immediately preceding the date of transfer.

Nature of Transfer:
Applicable to both Short-Term and Long-Term Capital Assets.

Type of New Asset to be Purchased:
Another agricultural land.

Time Limit for Investment:
The new agricultural land must be purchased within 2 years from the date of transfer of the original asset.

Exemption Amount:
The lower of the following:

• The amount of Capital Gain, or
• The Cost of the New Agricultural Land
  

Capital Gains Account Scheme (CGAS):
Applicable – The unutilized amount of capital gain should be deposited in a CGAS account before the due date of filing the income tax return.

Additional Conditions:

• If the newly acquired agricultural land is sold within 3 years, the previously claimed exemption will be deducted from its cost of acquisition (COA) when computing capital gains.
• If the deposited amount under CGAS is not utilized within the specified time period, the unutilized balance becomes taxable as capital gains in the year the period expires.

Section 54D – Compulsory Acquisition of Land and Buildings Used in an Industrial Undertaking

Eligible Assessee: Any Assessee

Type of Asset Transferred:
Land or building that forms part of an industrial undertaking and has been used for business purposes for at least 2 years immediately before the transfer.

Nature of Transfer:
Applies to Long-Term Capital Assets that are compulsorily acquired.

Type of New Asset to be Purchased:
New land or building acquired for the purpose of shifting, re-establishing, or setting up the industrial undertaking.

Time Limit for Investment:
The new asset must be purchased within 3 years from the date of transfer or compulsory acquisition.

Exemption Amount:
The lower of the following amounts:

• The Long-Term Capital Gain (LTCG), or
• The Cost of the New Land or Building
  

Capital Gains Account Scheme (CGAS):
Applicable – Unutilized capital gains should be deposited in a CGAS account before the due date for filing the income tax return.

Additional Conditions:

• If the new asset is sold within 3 years, the amount of exemption previously claimed will be deducted from its cost of acquisition (COA) when computing future capital gains.
• If the deposited amount under CGAS is not utilized within the prescribed time limit, the unutilized balance will be taxable as capital gains in the year when the period expires.

Section 54EC – Investment in Specified Bonds

Eligible Assessee: Any Assessee

Type of Asset Transferred: Land, building, or both

Nature of Transfer: Long-term Capital Asset

Type of New Asset to be Purchased:
Bonds issued by NHAI (National Highways Authority of India) or RECL (Rural Electrification Corporation Limited), which are redeemable after 5 years and issued on or after 1st April 2018.

Time Limit for Investment:
Investment must be made within 6 months from the date of transfer.

Exemption Amount:
The lower of the following:

• Cost of the new asset × Capital Gain / Net Consideration, or
• Actual amount of capital gain, subject to a maximum limit of ₹50 lakh (in the year of transfer and the subsequent financial year combined).

Capital Gains Account Scheme (CGAS): Not Applicable

Additional Conditions:

• If the new bonds are sold within 5 years (previously 3 years before FY 2018–19), the exemption earlier claimed will be deducted from the cost of acquisition (COA) while calculating future capital gains.
• If a loan or advance is taken against the security of these specified bonds within 5 years, it will be deemed as a transfer, and the earlier exemption will become taxable as capital gains.
• The total investment in these specified bonds cannot exceed ₹50 lakh during the current and the immediately following financial year.

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Section 54EE – Investment in Units of a Specified Fund

Eligible Assessee: Any Assessee

Type of Asset Transferred: Long-term Capital Asset

Nature of Transfer: Long-term Capital Asset

Type of New Asset to be Purchased:
Units of a specified fund as notified by the Central Government.

Time Limit for Investment:
Investment must be made within 6 months from the date of transfer.

Exemption Amount:
The lower of the following:

• Cost of the new asset × Capital Gain / Net Consideration, or
• Actual amount of capital gain, subject to a maximum limit of ₹50 lakh.

Capital Gains Account Scheme (CGAS): Not Applicable

Additional Conditions:

• If the new asset is sold within 5 years (earlier 3 years before FY 2018–19), the exemption claimed earlier will be deducted from its cost of acquisition (COA) while computing capital gains.
• If a loan is taken against the security of the specified units within 5 years, the same will be treated as capital gains.
• The investment limit in these specified funds must not exceed ₹50 lakh in the current and the immediately following financial year.

Section 54F – Investment in a Residential House

Eligible Assessee: Individual or Hindu Undivided Family (HUF)

Type of Asset Transferred: Any long-term capital asset other than a residential house property

Nature of Transfer: Long-term Capital Asset

Type of New Asset to be Purchased: Residential house property

Time Limit for Investment:

• Purchase a residential house within 1 year before or 2 years after the date of transfer, or
• Construct a new house within 3 years from the date of transfer

Exemption Amount:
Calculated as —
(Cost of New Asset × Capital Gain) / Net Consideration, subject to a maximum of the total capital gain

Capital Gains Account Scheme (CGAS):
Applicable – The unutilized capital gains must be deposited in the CGAS account before the due date for filing the return of income.

Additional Conditions:

• If the new residential property is sold within 3 years from its purchase or construction, the earlier exempted amount will be deducted from its cost of acquisition (COA) while computing capital gains.
• If the amount deposited in CGAS is not utilized within the specified time period, the unutilized balance will become taxable as capital gains.
• The assessee cannot own more than two residential properties (the existing one and the newly purchased one). If another house property is acquired within the specified period, the previously claimed exemption will be withdrawn and taxed as capital gains.

Section 54G – Shifting of Industrial Undertaking from Urban to Rural Area

Eligible Assessee: Any assessee

Type of Asset Transferred: Capital assets such as plant, machinery, land, building, or rights in land or buildings used for an industrial undertaking located in an urban area

Type of Transfer: Long-term or Short-term Capital Asset

New Asset Purchased / Investment Includes:

• Purchase of new plant and machinery
  
• Acquisition of land or construction of a building in a new area
• Shifting of old assets and relocation of the undertaking to a non-urban (rural or SEZ) area
• Expenses incurred for the purpose of shifting and re-establishment

Time Limit for Investment:
Within 1 year before or 3 years after the date of transfer

Exemption Amount:
Long-term capital gain or cost of new asset, whichever is lower

Capital Gains Account Scheme (CGAS):
Applicable – The unutilized amount must be deposited before the due date of filing the income tax return

Additional Conditions:

• If the new asset is sold within 3 years, the exempted amount will be deducted from its cost of acquisition (COA) when computing future capital gains.
• If the CGAS deposit remains unused within the specified time limit, the unutilized balance will become taxable as capital gains.

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Section 54GA – Shifting of Industrial Undertaking from Urban Area to Special Economic Zone (SEZ)

Eligible Assessee: Any assessee

Type of Asset Transferred: Capital assets like plant, machinery, land, buildings, or rights in land or buildings used for an industrial undertaking located in an urban area

Type of Transfer: Long-term or Short-term Capital Asset

New Asset Purchased / Investment Includes:

• Purchase of new plant or machinery
  
• Acquisition of land or construction of a building in an SEZ area
• Relocation of existing assets and transfer of the undertaking to the SEZ
• Expenses incurred for shifting and establishment in the new location

Time Limit for Investment:
Within 1 year before or 3 years after the date of transfer

Exemption Amount:
Long-term capital gain or cost of new asset, whichever is lesser

Capital Gains Account Scheme (CGAS):
Applicable – Deposit required on or before the due date for filing the income tax return

Additional Conditions:

• If the new asset is transferred within 3 years, the exempted capital gain will be reduced from its COA to calculate capital gains.
• If the deposited amount under CGAS is not utilized within the specified time, the unused portion will be taxable as capital gains.

 

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