CAPITAL GAINS TAX ON PROPERTY
Understanding the tax implications associated with selling of a real estate asset is integral to maximizing returns from your property investment.
As per Income Tax Act, any gains made due to the sale of a capital asset (such as a house) is defined as Capital Gains and the tax paid on it referred to as Capital Gains Tax. The applicable tax rate for capital gains on house property depends on its classification based on the holding period as mentioned below:
PROPERTY LOAN
If a house property is bought by using proceeds from a home loan and is sold within a period of five years, then any tax benefits claimed under section 80C (principal repayment, stamp duty, registration) are reversed. The aggregate amount of deduction in previous years is added to the income of the individual in the year of sale and taxed accordingly. However, the deduction of interest payment claimed under Section 24 remains unchanged.
HOW TO SAVE TAX
As per Income Tax Act, there are a number of schemes under which a property seller can reduce or eliminate Capital Gains Tax. These provisions are however, only applicable for Long Term Capital Gains Tax. As per provisions of these sections, tax can be saved by re-investing the amount of capital gains in specific investment types within a specified period from date of sale.
SECTION 54
This section allows for exemption on long term capital gains arising to an individual or HUF from sale of residential property to the extent that such capital gains are invested as per the following criterion:
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Purchase of another residential property (including under construction property) within 1 year before or 2 years after the date of transfer/sale of the property.
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Construction of residential property within a period of three years from the date of transfer/sale of property.
In case the full amount of capital gains is not re-invested in another residential property as per above provision, the remaining amount can be invested as per Section 54 EC or it shall be proportionately taxed as long term capital gains.
Conditions
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The exemption as mentioned is allowed only for an amount of capital gains reinvested in 1 residential property situated in India. The new property should be in the name of the seller only.
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The new residential property so purchased or constructed is not sold / transferred before 3 years from date of acquisition. In case this property is sold before 3 years, then, for calculating the capital gains on this transfer, the cost of acquisition of this house property shall be reduced by the amount of capital gains exempt earlier and taxed as short term capital gains (even if holding period of this new asset is greater than 24 months but less than 36 months).
SECTION 54F
This section allows exemption on long term capital gains arising to an individual or HUF from sale of any long term asset other than residential property based on the amount of net sales consideration which is re-invested as per the following criterion:
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Purchase of another residential property (including under construction property) within 1 year before or 2 years after the date of transfer/sale of the property.
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Construction of residential property within a period of three years from the date of transfer/sale of property.
Section 54F allows exemption for the full capital gains amount when the entire net sales consideration is re-invested in another residential property. If the full net sales consideration is not re-invested, exemption is allowed proportionately as explained below:
Exemption = Capital Gains * (Amount Re-invested / Net Sales Consideration)
Conditions
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The exemption as mentioned is allowed only for an amount of capital gains reinvested in 1 residential property situated in India. The new property should be in the name of the seller only.
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Available only when the taxpayer does not own more than 1 residential property on the date of transfer of such asset other than the one which has been bought for claiming exemption under Section 54F.
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This exemption is reversed if the assessee sells this new property within 3 years of purchase or construction or purchases another residential property within 2 years of the sale of original asset or constructs a residential house other than the new house within 3 years of sale of original asset.
SECTION 54 EC
This section allows exemption on capital gains (up to Rs 50 lakhs) arising from transfer of any long term asset to the extent that such capital gains are invested in specified instruments as per the following criterion:
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Invest the long term capital gains for a minimum of three years (five years from 2018-19 onwards) in specified long term assets (designated bonds issued by NHAI, REC, PFC, NABARD, IRFC) within six months from date of such transfer up to a maximum of Rs 50 lakhs.
It may be noted that the interest on such bonds is not tax free and is liable to be paid as per the taxpayers applicable tax slab.
Conditions:
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In case the investment in long term specified asset is transferred or converted into money or used as collateral for taking a loan, the amount of capital gain exempt shall be reversed and taxed as long term capital gain of the previous year in which the long term specified bond is transferred or converted into money.
Amendments:
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With effect from financial year 2018-2019, to avail capital gains exemption under section 54EC, the holding period of long term specified assets (designated bonds) has been increased from 3 years to 5 years.
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From financial year 2018-2019 onwards, the exemption available under section 54EC of the Income Tax Act, has been restricted only to long term capital gain arising from transfer of long term capital assets being land or building or both. Earlier, this exemption was available on long term capital gains arising on transfer of any long term capital asset.
CAPITAL GAINS ACCOUNT SCHEME
Is a mechanism which provides timeline flexibility to taxpayers for making relevant investments to save on capital gains from sale of long capital term assets.
The provisions of Section 54, 54 EC and 54F provide a six month to three year window to re-invest the proceeds from capital gains on long term assets. However, the capital gain tax is liable to be paid in the financial year of the sale/transfer of the property. The Income tax return of the year of sale is required to submitted in the corresponding assessment year on or before the specified due date. Thus an assessee needs to make the relevant tax saving investments prior to filing for tax returns else the capital gains would become taxable.
In case where taxpayers needs more time to decide on choosing the correct instrument/residential property for availing of exemption on long term capital gains, they may chose to temporarily park the capital gains from sale of long term asset in Capital Gains Account Scheme and furnish proof of such deposit while filing for tax returns.
There are different options available for a deposit under capital gains account scheme and the interest on these deposits depends on the type of deposit (saving account / term deposit account etc.). Interest on such deposit is taxed at the applicable tax slab of the assessee.
Deposits made in the Capital Gains Account Scheme can be withdrawn at any time and used for the defined purpose. However, if an assessee does not utilize the amount in the capital gains account scheme for purchase or construction of a house within the stipulated period, the amount not utilized shall be treated as Capital Gains of the year in which 3 years is completed form the date of sale of original asset and taxed as long term capital gains of that year.
CONCLUSION
It can be noted from the above discussion that an astute understanding of the provisions of capital gains tax on capital assets can help in significantly enhancing the returns from a property purchase. In case of real estate, the decision on the holding period and choice of appropriate tax saving instrument is key for optimal tax efficiency.