The grandfathering rule is a method for calculating the long-term capital gains tax on assets bought before March 2018, when the government did not introduce the LTCG tax. So, the rule will apply if a person wants to sell an asset purchased before LTCG tax regulation.

In 2018, the government introduced Section 112A in tax rules for levying an LTCG of 10 per cent on long-term gains from equity or equity-oriented mutual funds. It applies to investments made on or after February 1, 2018, and won’t apply to assets redeemed by January 31, 2018.

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How LTCG Is Calculated

Under the grandfathering rule, LTCG is calculated by deducting the cost from the sales value. The acquisition cost is calculated using a formula that reduces tax liability on such assets.

For example, the grandfathering rule can reduce the net tax liability on gains from assets held for over 7-8 years. Let’s assume you invested Rs 1 lakh in March 2015. The market value of the investment was Rs 2 lakh on January 31, 2018, and you sold it in March 2024 at 3.5 lakh—a net gain of Rs 2.5 lakh. However, using the grandfather rule, the gain is only Rs 1.5 lakh; thus, the tax liability is reduced from Rs 25,000 to Rs 15,000. 

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Let’s consider another scenario with the same investment amount. Assume the fair market value was Rs 50,000 on January 31, 2018, and the investor sold the investments in March 2024 at Rs 80,000. Using the grandfather formula, it will not be considered a gain of Rs 30,000 but a loss of Rs 20,000 (80,000-1,00,000 /Sales-Cost=LTCG (cost of acquisition is the actual cost or the lower of the sales prices and fair market value on January 31, 2018, whichever is higher). 

Tax-Loss Harvesting

As the financial year ends, many investors will look for tax-loss harvesting strategies, including the grandfathering rule, to offset losses against capital gains and reduce tax liability. This exercise is vital because adjusting gains with losses reduces the net capital gain and, thus, the taxpayer’s tax liability.

As per the income tax rules, any profit from transferring a capital asset during a financial year is taxed under the ‘Capital Gains’ head. At the same time, one can adjust a loss under capital gains head against a capital gain in the same year or carry it forward to the following year.