Tax implications of stock market investments: Short-term vs. long-term gains and tax strategies

Investing in the stock market is a lucrative avenue. However, there’s no such thing as a free meal. Earnings from your stock market investments are subject to taxation in the form of capital gains tax. Depending on the investment’s holding period, they are classified as short and long-term capital gains tax. Each of these taxes comes with a different set of implications. Understanding these tax implications is needed because they influence the post-tax returns and will help in shaping your investment strategies. 

In this article, you will be introduced to short-term and long-term capital gains. You will also learn how they are calculated, taxation rates, and their differences. 

Short-term capital gains 

Any profit earned from the sale of capital assets, including shares, securities, mutual funds, etc. (equity-oriented), that you hold for up to a year or less is known as a short-term capital gain. According to the tax slabs announced in the Union Budget 2024, these gains are liable to be taxed at 20%. This is a significant increase from the previous rate of 15%. 

Here is how this works: Suppose you purchase stocks for Rs.1,000 and decide to hold them for 6 months. Thereafter, you sell them for Rs.1,500. Your capital gain is Rs.500, which will be taxed at 20%. So, the short-term capital gains tax payable is Rs.100. 

Long-term capital gains 

Any earnings from the sale of capital assets, including securities, shares, mutual funds, etc. that you hold for more than a year is known as long-term capital gain. These gains are currently taxed at 12.5%. However, earnings up to Rs.1,25,000 are exempt from taxation. This is a significant increase from the previous threshold of Rs.1,00,000.

Let us use the previous example to calculate long-term capital gains tax. Instead of selling the shares after 6 months, let’s assume you hold them for two years, and their selling price is Rs.2,000. Your capital gains on sale are Rs.1,000, which will be taxed. However, according to the recent Budget, this tax is applicable only on gains exceeding Rs.1,25,000. Until this limit, no long-term capital gains tax is payable. 

Short-term vs long-term capital gains tax 

Here are the differences between short and long-term capital gains taxes applicable to stock market investments. 

Duration

The primary difference between these capital gains taxes is the holding period. Whenever you hold an equity oriented investment for a year or less, you are liable to pay short-term capital gains tax on any earnings. If the duration exceeds a year, long-term capital gains tax is applicable. However, this applies only to listed equity shares and equity-oriented mutual fund units. This limit for holding is up to 24 months in the case of unlisted equity shares, movable assets, and immovable assets (subject to conditions).

Tax rates

An obvious difference between these taxes is the taxation rate. Short-term capital gains are taxed at 20%. This is significantly higher than the 12.5% uniform rate at which long-term capital gains are taxed. The short-term capital gains tax rate can significantly inflate your tax liability. On the other hand, the long-term rate is quite low, and this can reduce your overall tax burden if you are willing to hold investments for over a year. This difference in tax rates makes long-term investing seem more lucrative. 

Exemptions

The short-term capital gains tax applies to all earnings from the sale of capital assets in the stock market without any exception. However, long-term capital gains tax exempts earnings less than Rs.1,25,000. So, your long-term capital gains will be taxed at 12.5% only after exceeding the limit of Rs.1,25,000. 

Any earnings from your stock market investments are subject to capital gains tax. Depending on the holding period of the investment, you are liable to pay either short or long-term capital gains tax. Considering this tax implication is necessary since it ultimately influences your overall earnings. The choice between the two depends primarily on your investment duration, risk appetite and financial objectives. Long-term gains have a lower taxation rate, but the investment horizon is longer.

On the other hand, short-term gains make for quick earnings but are accompanied by higher tax liabilities. By understanding what these taxes mean, you can make informed investment decisions. With a little planning, you can increase your earnings while reducing your tax liabilities.