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How does the 1 lakh LTCG tax exemption work?

You should book 1 lakh in Long term capital gains on equity or equity mutual funds every year. Why?

Because the first INR 1 lakh in capital gains is considered exempt. Any LTCG (on equity) above INR 1 lakh will be taxed at 10% (plus surcharge and cess).

Here’s what’s covered:


Long Term Capital Gains If your Indian equity shares/ mutual funds are held for more than 1 year, they are considered a long term capital asset.

LTCG on sale of these securities is taxed at 10% (plus surcharge and cess). Note: No indexation is allowed here.

However, like we discussed above, the first 1 lakh in LTCG on equity is exempt from tax.


Debt mutual funds/ US stocks?

Before you ask, this 1 lakh exemption applies only to Indian equity shares/ equity mutual funds. Debt mutual funds or US stocks (or other foreign stocks) are not covered here.

More on tax on US stocks here. And here’s the tax on all securities (including debt funds).

Devil in the detail - Zero rated not exempt

We’ve been saying that LTCG on equity is exempt upto INR 1 lakh. That is not actually 100% true – the first 1 lakh is actually taxed at a zero rate.


Why is this relevant you ask? Doesn’t zero rate mean no tax? You’d be right – except in the below scenario.


Example:

Mr. Ash has taxable salary of INR 4 lakh and income from other sources (interest on FD and savings account) of INR 80k. Mr. Ash is smart. He knows that he pays no tax if his income is less than INR 5 lakh. His friend told him that he can book LTCG of upto INR 1 lakh and pay no tax on this too. Since it is “exempt income”. He went ahead and sold his index fund and booked a profit of INR 1 lakh.

This is where tax planning goes for a toss.

Mr. Ash’s taxable income will be calculated as under:












Notice that his total income has exceeded INR 5 lakh. This means he will not get the rebate under Section 87A.


Here’s how his tax will be calculated:


Tax on LTCG at 0% - 0

Tax on other Income (Slab rates) - 11,500


Unfortunately, booking the 1 lakh in LTCG on equity has caused a tax liability of INR 11,500 (plus cess). Mr. Ash would’ve been better off not booking the capital gains at all.



Devil in the detail - Loss adjusted before exemption


There’s another devil in the detail that you should remember before tax planning for harvesting your INR 1 lakh limit.


Say you have a brought forward loss of INR 50,000 from FY 2020-21. You decide to book INR 1 lakh in LTCG on equity to use your tax-free limit.


The gains are first adjusted against brought forward losses. This means that in order to efficiently use your 1 lakh limit, you should book INR 1.5 lakh in profits.


Need help in planning out your taxes? Feel free to contact us. Our team of experts is always happy to help!

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