How does inflation affect capital gains?

Inflation can have an impact on capital gains by affecting the purchasing power of the gains. When calculating capital gains, the original cost of the asset is typically adjusted for inflation using a process called indexation. Indexation allows for the increase in the cost of the asset due to inflation over the holding period.

By adjusting the cost of the asset for inflation, indexation reduces the taxable capital gains. This is particularly relevant for longterm capital gains on assets held for a considerable period of time, such as real estate or debtoriented investments.

The purpose of indexation is to account for the erosion in the value of money over time due to inflation. It ensures that the tax calculation is fair and reflects the real gain in purchasing power.

By incorporating indexation, the impact of inflation on capital gains is mitigated, and individuals are not taxed on the portion of the gains that is solely due to inflation. This helps to maintain the purchasing power of the capital gains after accounting for inflation.