How to save capital gains tax on property sale?
Property sales are usually high-ticket deals and hence the tax outflow on the profit generated could be heavy. The Indian Government has provided property sellers with multiple tax exemptions, which can help them reduce and in some cases even eliminate one’s payable long-term capital gains tax. We will guide you on how to save your capital gains tax.
The process of property sale attracts taxation, which depends on the number of years you have held the asset for. The Government has made several policies conducive to maintain a steady flow of realty transactions in the economy. Consequently, there are capital gains tax that are associated with property transactions, particularly to the sellers. To help you understand it better and equip you with ways to save on such taxes, here is a breakdown for you.
Assume that you have sold your property and have earned a profit on it as well. If you held it for one year and then sold it, the profit earned from its sale will be considered as short-term capital gains. Such gains are added to your taxable income and are taxed according to the income slab applicable to you. There are no exemptions available to save such tax. However, if you had held your property, let us suppose for five years, the profit earned from its sale would be considered as long-term capital gains. You will have to pay 20 percent tax on it, which is known as Long-Term Capital Gains (LTCG) Tax. Owing to the high-ticket nature of real estate deals, the tax outgo can be a hefty amount. But wouldn’t you want to save on capital gains tax on property sale? There are multiple exemptions which you can take advantage of to lower or eliminate your payable LTCG tax.
Purchase or construct a residential property
Under Section 54 of the Income Tax Act, 1961, an individual selling a residential property can make use of tax exemption on long-term capital gains if such gains are used to purchase or construct a residential property. Remember, this exemption is only applicable to long-term capital assets (in our case, immovable properties with a holding period of more than two years).
The following conditions need to be followed to obtain this exemption:
- The seller must purchase a residential property either one year prior to the sale of the original property or two years after the sale of the original property.
If you are constructing a house using the capital gains, then the construction of the same should be concluded within three years from the date of sale of the original property.
- The new residential property has to be located in India.
- The exemption will be taken back if the newly purchased or constructed property is sold within three years of its purchase/construction.
According to the Finance Act, 2019, with effect from Financial Year 2019-20 (FY 2019-20) – corresponding to Assessment Year 2020-21 – the capital gain exemption under Section 54 has been made available for the purchase of up to two residential properties in India. The exemption for this is subject to the long-term capital gain not being more than Rs 2 crore. In addition, this exemption is available only once in the lifetime of a seller.
If the investment made in the new property exceeds the capital gains earned from the sale of the original property, the exemption shall be limited to the capital gain amount. If the investment made in the new property is lesser than the capital gains earned, then, the remaining capital gains shall be taxable at a flat rate of 20 percent.
Deposit the funds in a capital gains account
Identifying a suitable property to re-invest your capital gains into, arranging all of the required funds and getting the documentation in place can take some time. Accordingly, if you have not been able to re-invest your capital gains into a new property until the date of filing your income tax returns, then you may invest these gains in a ‘capital gains account’ in any of the branches of authorised banks (excluding rural branches of such banks) such as Bank of Baroda, as according to the Capital Gains Account Scheme, 1988. This deposit can be availed as an exemption from capital gains.
In case the deposited amount is not utilised within the specified period of two years (in case of purchase of new residential property) or three years (in case of construction of a new residential property), then, the deposit will be treated as short-term capital gains in the year within which the specified period lapses.
Invest the funds into capital gain bonds
If you do not want to re-invest your capital gains earned from the sale of your property into a new residential property and do not want to construct another one, you can invest your profits in ‘Capital Gain Bonds’ under Section 54EC of the Income Tax Act. These are also known as ’54EC bonds’ and are one of the most popular ways to save LTCG Tax.
A few conditions:
- The minimum investment into 54EC bonds is one bond amounting to Rs 10,000, and the maximum investment is 500 such bonds totalling Rs 50 lakh.
- Eligible bonds under Section 54EC are issued only by Power Finance Corporation Limited (PFC), National Highways Authority of India (NHAI), Rural Electrification Corporation Limited (REC), and Indian Railways Finance Corporation Limited (IRFC).
- These bonds come with a lock-in period of five years (effective since April 2018) and are not transferable to another person.
- 54EC bonds offer a five percent annual interest rate. However, this interest is taxable.
- The investment into these bonds must be made within six months of selling the property. In addition, the investment has to be made before the tax filing deadline.
Since these bonds are backed by the Government of India, the associated risk factor is minimal. Also, they allow you to save tax whilst earning interest income.
As you can see, the Income Tax Department has provided excellent options for you to save long-term capital gains tax. It would be sensitive to spend some time thinking about your personal finance goals before making such a decision. You can also speak to financial experts about such investments.