Selling a property is usually a high-ticket deal, and hence the tax outflow on its profit generated could be heavy. The Indian Government has provided property sellers with many tax exemptions that can help reduce tax liability and, in some cases, even eliminate one’s taxes to be paid on such capital gains.
In this blog, we will discuss the ways in which a seller of residential property can save tax and reduce their tax liability arising from capital gains made from the sale of residential property.
Understanding Capital Gains
To simplify capital gains, these are profits that are made from the sale of investments like stocks, bonds, or real estate. In the case of real estate, when you sell the property for more value than it was acquired, a capital gain is made, and such gains are taxable as per the Indian Income Tax Act, 1961.
Now let’s understand how capital gains are taxed on the sale of a residential property. Capital gains can be categorized into two types: Long-term capital gains and Short-term capital gains.
- If you sell your land/house/property within 24 months (2 years) of acquiring it, it is considered to be a short-term capital gain and is taxed as per the individual’s slab rate.
- If you sell it after 24 months (2 years), it is considered to be a long-term capital gain and is taxed at the rate of 20% with the benefit of indexation.
How to calculate Capital Gains?
Before understanding the calculation of capital gains, let us first know what the cost of the property actually means. Cost of property means the money that you spend on acquiring the property, inclusive of any stamp duty and registration fees, as well as money spent on the property’s improvement or renovation. So, if you purchase a house for ₹60 lakhs and incur ₹20 lakhs to renovate it, then the actual cost of the house for computation of tax will be ₹80 lakhs.
To calculate short-term capital gains, from the total sale price of the property, deduct the price at which it was acquired, and the resulting amount is your short-term capital gain.
Example: Cost of property is ₹80 lakhs and sale price is ₹1.5 Crore
₹1,50,00,000 – ₹80,00,000 = ₹70,00,000
To calculate long-term capital gains, the only difference is that you are allowed to deduct the indexed cost of acquisition from the sale price. Indexation is done by applying CII (Cost Inflation Index). This increases your cost and lowers your gains since the purchase price is adjusted for the impact of inflation.
Example: Cost of Property is ₹80 lakhs and sale price is ₹1.5 Crore
CII for the year of purchase is 100, and CII for the year of sale is 150
The indexed cost of the property will be ₹80,00,000*150/100 = ₹1,20,00,000
Hence, LTCG will be ₹30,00,000 (₹1,50,00,000 – ₹1,20,00,000)
Tax savings on the sale of house property
Under the provisions of the Income Tax Act, 1961, let us discuss the options available to us, to save capital gains tax on the sale of residential property. However, it is to be noted that the tax-saving options are only available for long-term capital gains.
Section 54 on purchase of new house property
Deduction under section 54 is applicable only when you sell the property at least after two years of purchase and further purchase a new house property with the gains arising from the sale. The house must be purchased 1 year before the date of transfer or within 2 years after that sale.
The proceeds of capital gains can also be used to save tax by constructing a house within 3 years of purchase or construction. It is to be noted that if you spend less amount on the purchase of new property than the gains you have made on the sale, the remaining amount will be subject to tax.
Section 54EC on purchase of specific bonds
Sellers need not necessarily reinvest their capital gains received from the sale of the property to purchase a new property to claim the deduction. They could do so by reinvesting the capital gains into specific bonds.
Section 54EC allows sellers of house property to claim exemption on the gains that they have made by reinvesting it in certain specified bonds within six months from the date of the sale of the house. Section 54EC specified bonds include those issued by the Railway Finance Corporation, the National Highways Authority of India, the Rural Electrification Corporation, etc.
Note that the upper limit is capped at ₹50 lakhs for this investment with a lock-in period of five years. Along with claiming the tax benefits, you also get interest paid at the rate of 5.25% annually, which will be taxable. However, the maturity proceeds of the bonds will be exempted from tax.
This section would be available if the profit is reinvested in subscribing equity shares of small or medium enterprises or in eligible start-ups. If you are buying assets and other such equipment for your start-up with the sale proceeds of a house property, you could claim deductions under this section.
The equity shares of the company and the new assets or equipment purchased by the company cannot be sold for a period of five years from the date of purchase. However, in case of the sale or transfer, the exemption allowed under section 54GB would be withdrawn. The amount of exemption claimed under section 54GB would be taxable in the previous year in which the company’s equity shares or the new equipment were purchased.
To summarize, if you are planning to sell your house property, ascertain the type of capital gains you get and calculate the taxable figure accordingly. To reduce your tax liability and save taxes, make use of the Section 54 provision mentioned above. You can additionally set off any previous year’s capital losses incurred on the sale of stocks, gold, or real estate against the capital gains made on the sale of residential property in the current year.
Disclaimer: The views expressed in the blog are purely based on our research and personal opinion. Although we do not condone misinformation, we do not intend to be regarded as a source of advice or guarantee. Kindly consult an expert before making any decision based on the insights we have provided.