Tax: Losing out on short term capital assets

Arnav PandyaFinancial Advisor

The main issue for a lot of individuals is the tax that they end up paying when there is capital gain and hence this makes them want to convert their capital gains into long term capital gains. What is also significant is that having short term capital gains can actually decrease the benefit for the individuals as there are several additional factors that come into play. One has to look at these conditions because they will ensure that the real position with respect to the impact of the capital gains comes into the picture. Here are some additional factors in this respect.

Indexation benefit

When it comes to the calculation of capital gains one of the ways in which an individual can reduce their tax burden is through the use of indexation. This is nothing but the adjustment of the cost of the asset for the individual due to the impact of inflation over the holding time period. This ensures that there is an addition to the cost and which will lead to the reduction of the capital gains that is present for tax calculations.

This in turn leads to a lower tax liability which is beneficial for the individual. The indexation benefit is based on the cost inflation index numbers that are declared by the tax authorities every year. There is however a restriction on this type of indexation benefit because it is possible to use indexation only when there is a long term capital gains.

If there is a short term capital gains then there is no indexation benefit and the comparison for the calculation of the capital gains has to be directly between the cost and the sale price. This could prove to be a bit of a dampener as the capital gains would turn out to be high without the benefit of indexation. In case of a house property the short term capital gains would occur as long as the asset is held for a period of less than three years and hence in this case too there would not be any indexation benefit that would be available.

Tax savings

There are different ways that are available to save the tax that has to be paid on capital gains. One of the best ways in which this can be done is by reinvestment in other assets especially property and bonds. There are different sections under the Income Tax Act wherein long term capital gains made on sale of property and other assets can be reinvested into another property within a specified time period or it could be invested into specified bonds (under Section 54EC) and this would lead to a reduction or elimination of the tax to be paid depending upon the amount invested. There is no such benefit that is available for short term capital gains and the individual has no option to save the tax that would arise and this would mean that they end up compulsorily paying the tax without the benefit of options to try and reduce or eliminate this amount.

Setting off

There is one area where the short term capital gains has a slight advantage which is that short term capital loss can be set off against both long term capital gains as well as short term capital gains. However this kind of flexibility might not be beneficial at the end of the day because the rate for short term capital gains is higher than what one would experience for long term capital gains. On an overall basis the set off flexibility is a benefit but it with a higher rate even a small part of the capital gains can end up having a larger impact as far as the individuals tax liability is concerned.