Grandfathering (LTCG)
Grandfathering in the LTCG context refers to the protection of unrealised long-term capital gains on listed equities and equity mutual funds that accrued up to January 31, 2018 — the day before the LTCG tax was reintroduced by Budget 2018 — with gains up to that date deemed tax-free.
When the Finance Act 2018 reintroduced LTCG tax on listed equities after a 14-year exemption, it included a critical transitional provision — the grandfathering clause — to avoid taxing gains that had accumulated under a regime that promised tax-free returns. Under this clause, the cost of acquisition for shares and equity funds purchased before February 1, 2018 was deemed to be the higher of the actual purchase price or the Fair Market Value (FMV) as of January 31, 2018.
The FMV as of January 31, 2018 for a listed share is its highest traded price on that date on a recognised stock exchange. If the stock was not traded on January 31, 2018, the FMV is the highest price on the last trading day before that date. For equity mutual funds, the NAV as of January 31, 2018 serves as the FMV. This grandfathered cost effectively makes all appreciation up to that date tax-free.
The practical computation works as follows: if a share was purchased in 2012 at ₹100, its FMV on January 31, 2018 was ₹400, and it was transferred in FY 2024-25 at ₹700, the deemed cost of acquisition is ₹400 (higher of ₹100 actual cost and ₹400 FMV). The taxable LTCG is therefore ₹300 (₹700 − ₹400), not ₹600. The ₹300 gain from 2012 to 2018 is grandfathered and tax-exempt.
However, there is a cap on grandfathering: the deemed cost cannot exceed the actual sale price. If the sale price in the above example was ₹350 (below the FMV of ₹400), the gain would be computed as ₹350 − ₹350 = ₹0 (with a floor ensuring no artificial loss is created solely due to the grandfathering rule). The Income Tax Rules under Section 55(2)(ac) specify these detailed computational mechanics.
For long-tenure investors who held quality stocks from before 2018, grandfathering significantly reduces the effective tax burden. Many investors who accumulated blue-chip equities during the 2014–2018 bull run saw stocks double or triple, and the FMV on January 31, 2018 locks in those gains tax-free. Understanding grandfathering is therefore essential for anyone computing LTCG on pre-2018 purchases — relying on actual purchase price alone will result in significant overstatement of tax liability.