Grandfathering Clause for LTCG: Does It Still Apply in 2025-26?

What Is the Grandfathering Clause?

When the government reintroduced LTCG tax on listed equity shares through Section 112A in the Union Budget 2018, it included a grandfathering clause to protect gains that had accrued before the announcement date. The clause ensures that capital gains earned before February 1, 2018 are not taxed under the new provision.

Before this budget, long-term capital gains on listed equity shares were entirely exempt from tax under Section 10(38). Investors who had accumulated significant gains over many years before 2018 would have faced an unfair retrospective tax if the new LTCG tax applied to all historical gains. The grandfathering clause addressed this concern.

The mechanism is simple: for shares purchased before February 1, 2018, the cost of acquisition is deemed to be the higher of the actual purchase price or the fair market value (FMV) as of January 31, 2018. This ensures that only the gain accrued after January 31, 2018 is subject to the 12.5% LTCG tax.

The grandfathering clause has no expiry date. It continues to apply in FY 2025-26 and will remain applicable as long as you hold shares that were purchased before February 1, 2018. This is particularly relevant for long-term investors who still hold stocks bought many years ago.

The Grandfathering Formula

The cost of acquisition for grandfathered shares is calculated using a specific formula prescribed by the Income Tax Act:

Cost of Acquisition = Min(Sale Price, Max(Actual Purchase Price, FMV on Jan 31, 2018))

Let us break this down step by step:

Step 1: Determine the FMV on January 31, 2018. This is the highest trading price of the share on any recognized stock exchange on January 31, 2018. If the share was not traded on that date, use the highest price on the most recent trading day before January 31, 2018.

Step 2: Compare the FMV with your actual purchase price. Take the higher of the two. This is the base cost before the cap.

Step 3: Compare the result from Step 2 with the actual sale price. Take the lower of the two. This is your final cost of acquisition.

The Step 3 cap prevents creating an artificial loss using the grandfathering clause. If the FMV on January 31, 2018 was Rs 500, you bought at Rs 300, and you sell at Rs 400, your cost cannot be Rs 500 (which would create a false loss of Rs 100). Instead, the cost is capped at the sale price of Rs 400, resulting in zero gain rather than a loss.

This three-step formula covers all possible scenarios and ensures a fair tax treatment regardless of how the stock price has moved since 2018.

Worked Examples of Grandfathering

How to Find the FMV on January 31, 2018

Grandfathering and FIFO Interaction

When you hold shares of the same stock purchased in multiple lots, some before February 1, 2018 and some after, FIFO determines which lots are sold first. Since the oldest lots are sold first under FIFO, pre-2018 lots are consumed before post-2018 lots.

This has an important planning implication. If you have both pre-2018 and post-2018 lots of the same stock, the grandfathered lots will be sold first. The grandfathered cost basis may be significantly higher than the actual purchase price, resulting in lower taxable LTCG.

Example: Kiran holds Reliance Industries shares: - Lot 1: 100 shares bought in 2016 at Rs 500 (FMV on Jan 31, 2018: Rs 900) - Lot 2: 100 shares bought in 2023 at Rs 2,400

Current price: Rs 2,800. If Kiran sells 100 shares:

FIFO sells Lot 1 first. Grandfathered cost: Max(500, 900) = Rs 900. Cap: Min(2800, 900) = Rs 900. LTCG: Rs 2,800 - Rs 900 = Rs 1,900 per share. Total: Rs 1,90,000.

If Lot 2 were sold instead (not allowed under FIFO): Cost: Rs 2,400. LTCG: Rs 400 per share. Total: Rs 40,000.

FIFO forces the grandfathered lot to be sold first, which in this case creates a larger gain because the FMV was Rs 900 but the stock is now Rs 2,800. The grandfathering protects the Rs 400 gain from pre-2018, but the Rs 1,900 post-2018 gain is fully taxable.

Understanding this interaction is critical for planning gain harvesting. TaxHarvestLab accounts for grandfathering when calculating FIFO-based gains for every holding in your portfolio.

Does Grandfathering Apply After Budget 2024 Changes?

Yes, the grandfathering clause continues to apply after the Union Budget 2024 changes. Budget 2024 changed the LTCG tax rate from 10% to 12.5% and increased the annual exemption from Rs 1,00,000 to Rs 1,25,000, but it did not modify or remove the grandfathering provision.

The cost of acquisition for pre-February 1, 2018 shares is still calculated using the same formula: Min(Sale Price, Max(Actual Purchase Price, FMV on Jan 31, 2018)). The only change is that the LTCG calculated using this formula is now taxed at 12.5% instead of 10%.

There has been no indication from the government that the grandfathering clause will be removed or modified in future budgets. It is a settled provision that protects the legitimate expectations of investors who held stocks before LTCG tax was reintroduced.

For investors who still hold pre-2018 stocks, the grandfathering clause remains a significant tax benefit. The longer the stock was held before 2018 and the more it appreciated during that period, the greater the protection provided by the grandfathering clause.

As a practical tip: if you are gain harvesting and have both pre-2018 and post-2018 lots, the pre-2018 lots will be sold first under FIFO. The grandfathered cost basis may reduce your taxable gain significantly, making these lots especially attractive for gain harvesting.

Impact on Gain Harvesting Strategy

The grandfathering clause has a specific impact on your gain harvesting strategy for pre-2018 holdings.

Because the grandfathered cost basis is higher than the actual purchase price, the taxable LTCG per share is lower. This means you can sell more shares while staying within the Rs 1,25,000 exemption limit.

Example: Meena holds 500 shares of HDFC Bank bought in 2015 at Rs 400. FMV on Jan 31, 2018: Rs 1,850. Current price: Rs 1,700.

Without grandfathering, her LTCG per share would be Rs 1,300 (Rs 1,700 - Rs 400). She could only sell 96 shares to stay within the Rs 1,25,000 exemption (96 x Rs 1,300 = Rs 1,24,800).

With grandfathering: Cost = Min(1700, Max(400, 1850)) = Min(1700, 1850) = Rs 1,700. LTCG per share: Rs 0. She can sell all 500 shares with zero LTCG tax.

This is an extreme example where the FMV exceeds the current price, but it illustrates the point. In many cases, the grandfathered cost significantly reduces the per-share gain, allowing you to sell more shares tax-free.

TaxHarvestLab automatically identifies holdings where grandfathering provides the greatest benefit and recommends these for priority gain harvesting. The tool calculates the exact grandfathered cost for each lot and determines the optimal quantity to sell.

Frequently Asked Questions