When you sell a long-term investment such as debt mutual funds, bonds, or real estate, you may have to pay tax on the profit earned. However, there’s a legitimate way to reduce this taxable amount — through indexation.
This simple yet powerful concept can significantly cut your capital gains tax if used wisely.
What Is Indexation?
Indexation adjusts the purchase price of an asset to account for inflation over the years.
The government releases a Cost Inflation Index (CII) every financial year, which is used to calculate this adjustment.
By using indexation, your purchase cost increases, which effectively reduces your taxable capital gain.
How Indexation Works — Example
Suppose you bought a debt mutual fund in FY 2018–19 for ₹1,00,000 and sold it in FY 2024–25 for ₹1,80,000.
- CII for FY 2018–19: 280
- CII for FY 2024–25: 363
Indexed Cost of Acquisition (ICOA) =
₹1,00,000 × (363 ÷ 280) = ₹1,29,642
Taxable capital gain = ₹1,80,000 – ₹1,29,642 = ₹50,358
Without indexation, your taxable gain would have been ₹80,000.
By using indexation, your tax liability is reduced on ₹29,642 worth of gains.
Who Can Avail Indexation Benefits?
Indexation applies to long-term capital assets, such as:
- Debt mutual funds (held for more than 3 years, for investments made before April 1, 2023)
- Bonds and debentures (except listed zero-coupon bonds)
- Real estate held for more than 2 years
- Gold ETFs and Sovereign Gold Bonds held beyond 3 years
Equity mutual funds and listed shares do not qualify for indexation benefits.
Tax Rates After Indexation
Long-term capital gains on assets eligible for indexation are generally taxed at 20% after indexation.
This means you pay 20% tax only on the inflation-adjusted profit, not the total capital gain.
Why Indexation Is Important
- Reduces your taxable income
- Accounts for the impact of inflation
- Encourages long-term investing
- Improves post-tax returns
In essence, indexation ensures you are taxed only on real profits, not on inflationary increases in value.
Final Thoughts
Indexation is one of the most effective and lawful methods to reduce capital gains tax in India.
By holding your investments longer and using the Cost Inflation Index correctly, you can optimize your tax outgo and retain more of your real returns.
Before redeeming your investments or selling property, always calculate how indexation could impact your taxes — the difference can be substantial.
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