Budget 2018: New long term capital gains tax means you have to save more to meet financial goals (2024)

One of the biggest fears of equity investors has come true: Long term-capital gains (LTCG) tax on equities is back. Expectedly, the announcement made by the Finance Minister on 1 February 2018 rattled the stock market, sending the markets on a down ward spiral. The Sensex tanked by more than 1,000 points (as on 2 February 2018) since the announcement. Grandfathering of capital gains till 31 Jan 2018—LTCG earned up to this date won’t be subject to tax—prevented the market from plummeting on Budget day, but it could not rein in the fall the day after.

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“Market has accepted 10% tax on LTCG because of the grandfathering of gains till 31 Jan 2018. However, it will realise other negatives like continuation of STT, not providing indexation benefit to long-term equity investors, etc. later,” predicted Dhiraj Relli, CEO, HDFC Securities on Budget day.

How LTCG impacts you


Since the securities transaction tax (STT) was introduced as an alternative to LTCG tax on equities, retaining STT was a bigger shock for investors. “The real disappointment was the continuation of STT along with the LTCG tax. Logically, there should be just one tax,” says Jayant Manglik, President, Religare Broking.

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Besides their return potential, equities drew investors because of tax-free gains, imposition of LTCG tax will now hurt inflows. “LTCG of 10% reduces the relative attractiveness of equity as an asset class and can act as a short-term dampener,” says Unmesh Kulkarni, Managing Director, Julius Baer Wealth Advisors.

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The attractiveness of equity compared to debt funds stands eroded because its tax advantage is now gone. While LTCG tax is 10% without indexation for equities, it is 20% for debt funds with indexation benefit. Assuming 8% return from debt funds and 5% inflation, the effective LTCG tax on debt funds works out to be 7.5%. However, equities will become attractive, if their returns are higher.

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How capital gains will be taxed

Holding equities will also get costlier now. “With STT and LTCG tax in place, the long-term cost of holding equities has gone up,” says Relli. Unlike domestic mutual funds, which don’t have to pay LTCG tax, foreign institutional investors will now have to pay tax on their trades which will push up their costs.

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Also, though the grandfathering clause provides some relief, it has also made things difficult. “The highly technical construct of the amendment seeking to grandfather the appreciation in the value of the stocks and mutual fund units up to 31 Jan 2018, has made things complex for investors and fund managers,” says Tejas Desai, Tax Partner, Financial Services, EY India. “FII investments may be affected in the short run as tax compliance stands to increase their operational costs,” says Manglik.

The stock market volatility may also go up now because the LTCG tax will result in a behavioural change among investors. “Since the difference between the STCG and LTCG is only 5% now, few investors may wait for a year to sell. Resultantly, the stock market volatility will increase due to increased shortterm activity,” says Relli.

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Investors, however, can now exercise greater freedom when it comes to redeeming their equity investments. As the difference between LTCG and STCG is 5%, investors who had wait for an entire year just to avail of the tax benefits, even if they wanted to book profits earlier, won’t have to stay invested. On several occasions, waiting for an entire year has proved to be costly for investors. “Investment decisions will now be based on the market situation and not based on tax concerns,” says Dinesh Rohira, Founder and CEO, 5nance.com.

Monthly investments to build Rs 10 lakh corpus
You need to invest more to build the same corpus

*12% returns will be reduced to 10.8% at 10% tax. But comparison is with 11% return to account for no LTCG tax up to Rs 1 lakh.

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The way out
Given that LTCG on equities is tax free only up to Rs 1 lakh per financial year, investors need to pare down their return expectations. “Though there will be some cushion due to the Rs 1 lakh exemption limit, investors need to bring down their return expectation at bit and invest more to achieve their goals,” says Melvin Joseph, Founder, Finvin Financial Planners.

How much should this increase be? “The exact additional sum you will need to invest to make up for the fall in your equity portfolio return will depend on your investment horizon and your return expectations. As a thumb rule, now you need to increase investment by 10-25%,” says Rohira. The additional amount you need to invest to build the desired corpus goes up significantly, with longer holding periods. This is because the impact of a 1% cut in returns on account of LTCG tax gets significantly higher with longer investment periods due to the impact of compounding.

Another strategy can be to make use of the tax exemption provision and book profits up to Rs 1 lakh per financial year and reduce LTCG tax outgo. Please note, you can’t carry forward the Rs 1 lakh sum—you cannot claim Rs 10 lakh exemption over a 10 year period. So, you will have to book profits each year. “Instead of accumulating capital gains forever, investors now need to churn their portfolio (book profit and invest again in other assets) on a regular basis to lower their tax liability,” says Joseph.

The benefit of this regular churning will depend on the size of your total corpus. “Churning will work well for retail investors whose portfolio size is small. But it becomes less effective for high-net individuals and may not be worth the trouble,” says Rohira. To illustrate, if an investor’s total equity corpus is Rs 5 lakh, his annual return at 12% will be just Rs 60,000. This entire capital gain can be made tax free by churning. Now consider an investor with an equity corpus of Rs 25 lakh. At the same rate of return, is annual gain will be Rs 3 lakh.

After saving tax on Rs 1 lakh, he will have to pay tax on the remaining Rs 2 lakh, limiting the impact of churning. Finally, for an investor with an equity corpus is Rs 1 crore, capital gain will be Rs 12 lakh. The tax benefit on Rs 1 lakh will be insignificant for him, and so churning may not be worth the effort.

If you are interested in following the annual profit booking and churning strategy, you should keep two things in mind. First, you must reinvest the proceeds and not divert them for consumption, or you will miss out on the power of compounding and put your goals at risk. Second, you need to know about tax rules. There won’t be any issues, if you are shifting from one stock or mutual fund to another. However, you need to be careful, if you are selling a stock to book profit, and want to buy back the same stock.

“There is no rule which says that you can’t buy back a stock after you sell it. However, you need to keep some gap between the sale and the repurchase, so that the delivery of sales and purchase transactions happens separately,” says Monish Panda, Founder, Monish Panda & Associates.

Finally, a word of caution for those looking to invest in Ulips. While the government has not tinkered with the tax structure of Ulips, investing in Ulips will work only for the informed investors, who understand their complex cost structures. Since the commission on low-cost Ulips is minimal, even zero, agents won’t push them. So, if you are not alert, you may be miss-sold high cost Ulips or other opaque insurance products such as traditional plans. High surrender charges is another issue with these products. Also, Ulips tax advantage could also go. “To create parity on tax, the government may introduce tax on Ulips and, if it happens, investors will get trapped,” says Rohira.

Budget 2018: New long term capital gains tax means you have to save more to meet financial goals (2024)

FAQs

Can long-term capital gains push you into a higher tax bracket? ›

Long-term capital gains can't push you into a higher tax bracket, but short-term capital gains can. Understanding how capital gains work could help you avoid unintended tax consequences. If you're seeing significant growth in your investments, you may want to consult a financial advisor.

How to calculate long-term capital gain grandfathering? ›

The concept of grandfathering in the case of LTCG on the sale of equity investments works as follows:
  1. Fair Market Value ('FMV') of such investments; and.
  2. the Full Value of Consideration received or accruing as a result of the transfer of the capital asset i.e. the Sale Price.
Mar 13, 2024

How much do you have to spend to avoid capital gains tax? ›

Avoiding capital gains tax on your primary residence

You can sell your primary residence and avoid paying capital gains taxes on the first $250,000 of your profits if your tax-filing status is single, and up to $500,000 if married and filing jointly. The exemption is only available once every two years.

Do capital gains count towards AGI? ›

Capital Gains and Adjusted Gross Income (AGI)

Capital gains can be taxed differently, but they are still included in your adjusted gross income. This can affect the tax bracket you are in and your ability to participate in income-based investments.

Do long term gains count towards tax bracket? ›

Your long-term capital gains will not cause your ordinary income to be taxed at a higher rate. Ordinary income is calculated separately and taxed at ordinary income rates.

What is the highest bracket for long term capital gains tax? ›

The long-term capital gains tax rates are 0 percent, 15 percent and 20 percent, depending on your income. These rates are typically much lower than the ordinary income tax rate.

How do you calculate long term capital gains without indexation? ›

Subtract the ICOA from the FMV to determine the capital gains. If the capital gains are from the sale of equity shares or units of equity-oriented funds and these are taxed at a special rate of 10% without indexation or 20% with indexation.

How do you show long term capital gains with indexation? ›

How to calculate long-term capital gains tax on property? In case of long-term capital gain, capital gain = final sale price - (transfer cost + indexed acquisition cost + indexed house improvement cost).

How many years is considered long term capital gains? ›

Generally, if you hold the asset for more than one year before you dispose of it, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term.

At what age do you not pay capital gains? ›

Since the tax break for over 55s selling property was dropped in 1997, there is no capital gains tax exemption for seniors. This means right now, the law doesn't allow for any exemptions based on your age. Whether you're 65 or 95, seniors must pay capital gains tax where it's due.

Can you save on capital gains tax? ›

A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.

Do you have to pay capital gains after age 70 if you? ›

As of 2022, for a single filer aged 65 or older, if their total income is less than $40,000 (or $80,000 for couples), they don't owe any long-term capital gains tax. On the higher end, if a senior's income surpasses $441,450 (or $496,600 for couples), they'd be in the 20% long-term capital gains tax bracket.

Do capital gains get taxed twice? ›

The taxation of capital gains places a double tax on corporate income. Before shareholders face taxes, the business first faces the corporate income tax.

Is capital gains tax based on gross income or taxable income? ›

Federal long-term capital gains tax rates are based on adjusted gross income (AGI). The basic capital gains rates are 0%, 15%, and 20%, depending on your taxable income. The income thresholds for the capital gains tax rates are adjusted each year for inflation.

Can you spread capital gains over several years? ›

Taking capital gains in different years

Another option to discuss with your tax professional may be to “spread the sale over multiple tax years — that can help ease the burden,” says Jonathon McLaughlin, investment strategist for Bank of America.

Do long-term capital gains affect income? ›

Long-term capital gains are typically taxed at lower rates, meaning there may be a benefit to holding onto your assets for longer before you sell them. Short-term capital gains are taxed at the same rate as your ordinary income. Meanwhile, long-term gains are taxed at either 0%, 15%, or 20%.

Do capital gains increase taxable income? ›

Capital gains are generally included in taxable income, but in most cases, are taxed at a lower rate. A capital gain is realized when a capital asset is sold or exchanged at a price higher than its basis. Basis is an asset's purchase price, plus commissions and the cost of improvements less depreciation.

Can capital gains offset income? ›

Key Takeaways

You can use capital losses to offset capital gains during a tax year, allowing you to remove some income from your tax return. You can use a capital loss to offset ordinary income up to $3,000 per year If you don't have capital gains to offset the loss.

Is capital gains added to your total income and puts you in higher tax bracket in India? ›

Tax Rules for Debt Mutual Funds

It means you need to remain invested in these funds for at least three years to get the benefit of long-term capital gains tax. If redeemed within three years, the capital gains will be added to your income and will be taxed as per your income tax slab rate.

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