How to use basic exemption limit to lower capital gains tax in India

Indian residents and HUFs can use the basic exemption limit to lower capital gains tax. This provision under the Income Tax Act, 2025, remains available for Tax Year 2026-2027. Unused portions of the exemption limit can offset special-rate capital gains after normal income is accounted for. Non-residents, firms, and companies cannot claim this specific tax adjustment.

Incomes that are charged at a special rate, like long term capital gains and short term capital gains from listed equities, aren’t eligible for the Section 87A tax rebate to reduce income tax liability. But Indian residents and Hindu Undivided Families (HUFs) can benefit from the Rs 4 lakh basic exemption limit under the new tax regime, which helps in lowering capital gain tax liabilities.

Under the Income Tax Act, 2025, this provision has not been removed, this means that using the basic exemption limit to reduce capital gains tax liability is still an option for Tax Year 2026-2027.

Chartered Accountant Suresh Surana says that resident individuals or a resident Hindu Undivided Family (HUF) can use the unused basic exemption limit against certain capital gains that attract a special tax rate such as short-term capital gains on specified listed securities as well as long-term capital gains covered by the special capital-gains provisions. However, non-residents, firms and companies cannot claim this adjustment.

How does it work for Indian residents?

Shanmuga Prasad, Tax Partner, EY said to ET Wealth Online that a common misconception among taxpayers is that capital gains taxable at special rates, such as STCG and LTCG, cannot benefit from the basic exemption limit. However, resident taxpayers can utilise any unabsorbed portion of the basic exemption limit against eligible capital gains, thereby reducing their overall tax liability.

The Income-tax Act, 2025 largely continues the principles that existed under the earlier law. Accordingly, where a resident individual's total income, excluding such capital gains, is below the applicable basic exemption threshold, the exemption limit is first applied against income taxable at normal slab rates under both the old and the new tax regimes.

Prasad says that any remaining unutilised portion of the exemption limit may then be adjusted capital gains that would otherwise be subject to special rates of taxation, provided the taxpayer is a resident individual or a Hindu Undivided Family (HUF).

For example, where interest income is Rs 2lakh and capital gains total Rs 2.5 lakh (taxable at special rate), against a basic exemption limit of Rs 4 lakh (under new tax regime), the unutilised basic exemption of Rs 2 lakh (after adjustment of interest income of Rs 2 lakh) can be set off against the capital gains. As a result, only the balance Rs 50,000 would remain taxable at the applicable special rate.

Surana says: “Sections 196(2), 197(2) and 198(3) of the Income-tax Act, 2025 (corresponding to sections 111A, 112 and 112A of the Income-tax Act, 1961 respectively) specifically provide this benefit.”

For FY 2025–26 (AY 2026–27), the basic exemption limit under the default new tax regime is Rs 4 lakh. Under the old tax regime, the limit is Rs 2.5 lakh for a resident individual below 60 years of age and an HUF, Rs 3 lakh for a resident senior citizen aged 60 years or more but below 80 years, and Rs 5 lakh for a resident individual aged 80 years or more.

Example showing how to use basic exemption limit to reduce capital gain tax liability:

For example, assume that Mr. A, a 35-year-old Indian resident, earns interest income of Rs 1.5 lakh and short-term capital gains of Rs 4 lakh from listed equity shares (under Section 111A). The applicable special tax rate on such gains is 20%.

Conditions to follow for using basic exemption limit to reduce capital gains tax liability

The benefit of basic exemption is not available in every case. Surana says that the following conditions must be satisfied:

The taxpayer must be deriving the capital gains from the relevant Sections (as aforementioned) and must be a resident individual or a resident HUF. Non-residents, firms and companies cannot make this adjustment.

The income excluding such capital gains should be below the applicable basic exemption limit. The adjustment is available only to the extent of the shortfall between the basic exemption limit and the taxpayer's total income excluding such capital gains.

Only the unutilised portion of the basic exemption limit can be adjusted. If the basic exemption limit is already fully exhausted by normal income, no further adjustment against capital gains is available.

The adjustment is available under both the old and new tax regimes. However, the amount of relief may differ because the basic exemption limit varies depending on the tax regime and assessment year.

The following table summarises the holding period and tax rates applicable to an individual resident in India for FY 2025–26 (AY 2026–27) in case of key capital assets as follows.