Income Tax Rebate Confusion: Capital Gains Impact on Section 87A Threshold Explained
The 2023 Budget introduced a significant change in the income tax rebate under the new tax regime. The rebate under Section 87A was increased, effectively making income up to ₹7 lakh tax-free.in Union Budget 2025-26 it this limit is increased to ₹12 lakh However, many taxpayers are confused about how capital gains impact their eligibility for this rebate.
Understanding Section 87A Rebate
Section 87A provides a rebate to individual taxpayers whose total taxable income does not exceed a specified threshold. The key points are:
- Under the old tax regime, the rebate limit remains at ₹5 lakh.
- Under the new tax regime, the rebate applies up to ₹7 lakh for FY 2024-25
- Under the new tax regime, this rebate increased up to ₹12 lakh applicable for FY 2025-206 onwards.
- The rebate is 100% of tax liability, subject to a maximum limit of ₹25,000 for FY 24-25 and ₹60,000 for FY 2025-206 onwards.
However, this rebate is available only if the total taxable income (after deductions) does not exceed ₹7 lakh (FY 24-25) and ₹12 lakh (FY 25-26). Capital gains, particularly taxable capital gains, complicate this calculation.
How Capital Gains Affect Rebate Eligibility in FY 2024-25 & in FY 2025-26
The rebate under Section 87A applies only if net taxable income does not exceed ₹7 lakh ( ₹12 lakh for FY 2025-2026) However, capital gains are included in total taxable income, which can push the income above the limit, leading to tax liability even if salary income remains below the rebate threshold.
Types of Capital Gains and Their Impact
Capital gains are categorized as:
- Short-Term Capital Gains (STCG):
- STCG under Section 111A (on sale of listed equity shares, equity mutual funds, etc.) is taxed at 20%.
- Other STCGs (e.g., property, debt mutual funds) are taxed at slab rates.
- Long-Term Capital Gains (LTCG):
- LTCG on listed shares and equity mutual funds (above ₹1.25 lakh) is taxed at 12.5% under Section 112A.
- LTCG on other assets (property, debt mutual funds) is taxed at 20% with indexation if sold before 23rd July 2024 and 12.5% without indexation if sold on or after 23rd July 2024.
Since capital gains are taxable separately and not part of “normal income,” they may push taxable income above ₹7 lakh ( ₹12 lakh for FY 2025-2026), making the rebate under Section 87A unavailable.
Example 1: Salary Income Below ₹7 Lakh, No Capital Gains (FY 2024-25)
Let’s assume a taxpayer has:
- Salary Income: ₹6,50,000
- Standard Deduction: ₹50,000
- Net Taxable Income: ₹6,00,000
Since the taxable income remains below the rebate limit (₹7 lakh under the new tax regime), the rebate under Section 87A applies, and the final tax liability is zero.
Example 2: Salary Income Below ₹7 Lakh, No Capital Gains (FY 2025-26)
Let’s assume a taxpayer has:
- Salary Income: ₹11,50,000
- Standard Deduction: ₹75,000
- Net Taxable Income: ₹10,25,000
Since the taxable income remains below the rebate limit (₹12 lakh under the new tax regime), the rebate under Section 87A applies, and the final tax liability is zero
Example 3: Salary Income Below ₹7 Lakh, With Capital Gains (FY 2024-25)
Assume the same taxpayer now earns:
- Salary Income: ₹6,50,000
- Standard Deduction: ₹50,000
- STCG under Section 111A: ₹2,00,000
- Net Taxable Income: ₹8,00,000
Since taxable income exceeds ₹7 lakh, the rebate under Section 87A is lost, and tax is payable as per applicable rates:
- Tax on salary portion (up to ₹7 lakh): ₹25,000 (rebate applies)
- Tax on STCG (₹2 lakh @20%): ₹40,000
Total tax payable = ₹40,000.
Example 4: Salary Income Below ₹12 Lakh, With Capital Gains (FY 2025-26)
Assume the same taxpayer now earns:
- Salary Income: ₹10,50,000
- Standard Deduction: ₹75,000
- STCG under Section 111A: ₹2,00,000
- Net Taxable Income: ₹11,75,000
Since taxable income exceeds ₹12 lakh, the rebate under Section 87A is lost, and tax is payable as per applicable rates:
- Tax on salary portion (up to ₹12 lakh): ₹60,000 (rebate applies)
- Tax on STCG (₹2 lakh @20%): ₹40,000
Total tax payable = ₹40,000
Planning Tips to Optimize Tax Liability
Given the impact of capital gains on rebate eligibility, taxpayers should plan their investments carefully:
- Monitor total taxable income: If close to the threshold, avoid realizing capital gains in the same financial year.
- Use exemptions under Sections 54, 54F, 54EC: If selling property, reinvesting gains in another property or specified bonds can make them tax-exempt.
- Harvest LTCG strategically: Sell equity shares in a manner that LTCG stays within ₹1.25 lakh per financial year to avoid taxation.
- Split gains across financial years: If possible, defer part of the gains to the next financial year to keep income within the rebate threshold.
- Opt for the old regime if beneficial: If rebate eligibility is lost, assess whether the old regime (with deductions like HRA, 80C, 80D) provides better tax savings.
Conclusion
While the new tax regime’s rebate threshold of ₹7 lakh(₹12 lakh for FY 2025-26) offers relief to salaried taxpayers, capital gains can complicate tax calculations. If taxable income including capital gains exceeds threshold limit, the rebate under Section 87A is completely lost, leading to an unexpected tax liability. Strategic planning, exemptions, and careful financial decisions can help optimize tax payments and reduce liabilities.
Understanding these nuances is essential to making informed financial choices and ensuring compliance with the evolving tax laws.
