Capital Gain = (Selling Price - Buying Price) * (CII for Year of Sale/CII of year of purchase).
CII = Cost Inflation Index. The tax department recognises that inflation affects the value of money, and therfore understands that Rs. 1000 in 1981 is not the same as Rs. 1000 today. It therefore releases a "Cost Inflation Index" for every year, with 1981-82 being the base year with an index value of 100.
The actual CII table is updated each year, and usually the CII value for the current financial year is announced in August or September as a "Notification". Most notifications are absolutely gibberish, so wading through them to find the notification you need is a pain in the you-know-where.
So for those of you who want it, here's the CII value for 2006-07:
Notification no. 270, dated 19/09/2006:
CII Value for 2006-07 is 519.