The ₹1.25 Lakh Exemption Trick: Booking Long-Term Capital Gains (LTCG) Before the Year Ends

If you hold a long-term equity portfolio, you have an annual ₹1.25 lakh tax-free allowance that you are likely wasting. The Income Tax Act provides a specific exemption on Long-Term Capital Gains (LTCG) arising from equity investments. However, this is a "use it or lose it" benefit—if you don't book the gains by March 31st of the financial year, the exemption limit for that year permanently lapses.

For Financial Year (FY) 2025-26 (Assessment Year 2026-27), executing a simple "sell and buy back" strategy before the financial year ends allows you to legally step up your acquisition cost, saving you up to ₹15,625 in future taxes (₹1.25 lakh × 12.5% tax rate).

Understanding the Section 112A Exemption

Long-Term Capital Gains arise when you sell equity shares or equity-oriented mutual funds that you have held for more than 12 months.

According to the law, these gains are taxed at 12.5% (plus applicable surcharge and cess). However, the tax calculation is not levied directly from the first rupee of profit. The law provides an initial exemption limit of ₹1.25 lakh per financial year. You only pay the 12.5% tax on the LTCG amount that exceeds ₹1.25 lakh.

The strategic flaw most long-term "buy and hold" investors make is never selling. By holding assets for 5 or 10 years and then liquidating entirely, all accumulated gains hit the tax return in a single year, where only one year's ₹1.25 lakh limit is available. The remaining massive gains are fully taxed at 12.5%.

The "Tax-Free Booking" Strategy

To utilize this annual allowance, you must artificially trigger the gain before March 31st.

Step-by-Step Implementation

1. Identify Long-Term Holdings: Review your portfolio to find equity stocks or mutual funds held for more than 365 days that are currently showing an unrealized profit.
2. Calculate the Gain: Determine exactly how many units or shares you need to sell to generate a realized profit of precisely (or just under) ₹1.25 lakh.
3. Execute the Sell Order: Sell those specific shares or units before the final trading days of March to ensure the transaction settles within FY 2025-26. By realizing this ₹1.25 lakh gain, it becomes part of your annual income but is entirely tax-exempt.
4. Immediate Buy Back: On the same day or the following day, reinvest the entire proceeds by purchasing the exact same shares or mutual fund units.

By completing this cycle, your portfolio size and composition remain identical. However, the "purchase price" of those specific assets on the tax ledger has now been legally reset to the higher current market price. When you eventually sell them years down the line, your taxable profit will be significantly lower because the base cost was artificially stepped up.

Legal Reference: The Scope of Section 112A

This strategy relies entirely on a specific provision governing equity taxation.

Section 112A (Tax on Long-Term Capital Gains on Equity)—This section dictates that capital gains arising from the transfer of a long-term capital asset (being equity shares in a company or units of an equity-oriented fund) shall be taxed at the rate of 12.5% on the amount by which such long-term capital gains exceed ₹1,25,000.

The essential conditions to claim this exemption are:

• The asset must be an equity share or equity-oriented mutual fund.
• The holding period must exceed 12 months.
• Securities Transaction Tax (STT) must have been paid on the acquisition and transfer (for shares) or transfer (for mutual funds).

Common Mistakes When Booking LTCG

1. Ignoring the FIFO Rule: For mutual funds and shares held in a demat account, the Income Tax Department strictly applies the "First In, First Out" (FIFO) method for calculating gains. The first units you bought are assumed to be the first ones you sold. You cannot selectively choose to sell units bought recently to manipulate the holding period.
2. Triggering STCG Accidentally: If you miscalculate the holding period and sell assets held for 365 days or less, you will trigger Short-Term Capital Gains (STCG). STCG is taxed at a flat 20%—and importantly, the ₹1.25 lakh exemption does not apply to STCG.
3. Last-Minute Execution: Selling heavily on March 31st risks the trade settling in April (the new financial year) due to the T+1 settlement cycle. Always aim to execute these trades by the penultimate week of March to ensure the gain is recorded in FY 2025-26.

Integrating With Your Year-End Plan

Booking your ₹1.25 lakh LTCG is a zero-risk tax planning move that every equity investor should automate annually. Just remember to account for brokerage, STT, and exit loads (for mutual funds) to ensure the transaction costs don't eat into the tax savings.

To complement this strategy, evaluate your portfolio for losing assets as well. Read our comprehensive guide on Tax Loss Harvesting to see how offsetting strategies can further optimize your final tax liability before the March 15th Advance Tax Q4 Deadline.