What is the indexation benefit on Stocks and Mutual funds?

Indexation basically means considering the time value of money while calculating your profits. While we sell an asset, the purchase price of the asset needs to be adjusted according to the inflation rate using a standard index. This calculation process is termed as indexation.

Indexation helps us achieve a fair and reasonable figure for calculating long-term capital gains. This tells us what the cost of purchase would have been at the time of sale.

In other words, if you bought a house in 2005 for Rs 300,000 and plan to sell the same in 2017, indexation helps you calculate how much you would have paid for the house in 2017.

How to calculate Indexation in India?

Long Term Capital Gains Formula:

LTCG = Full value of consideration — (indexed cost of acquisition + indexed cost of improvement + cost of transfer)

Here:

Indexed cost of acquisition = cost of acquisition * cost inflation index of the year of transfer/cost inflation index in the year of acquisition.

The Cost Inflation Index (CII) is issued through a notification by the Income Tax Department each financial year. This CII is applied to the acquisition cost of the asset to ascertain the indexed cost of acquisition.

Note: If the property is purchased before 1981, CII of 1981–82 is considered. However, if the improvement is done before 1981, the cost of the improvement is not considered.

This indexation benefit is only applicable for non-equity mutual funds such as debt funds or properties like houses/land etc. It means that indexation benefit cannot be availed in equity mutual funds and stocks.

Scenario

You bought an apartment for Rs 5,00,000 in 2005. In January 2015, you sold it for Rs 15,00,000.

This means you need to pay capital gain tax at 20% on gains of Rs 4,35,000.

Cost Indexation Index for last 15 years