How You Can Plan Capital Gain Tax on Property

Any profit realised from selling a capital asset is considered a capital gain. The profit thus earned is categorised as an income. As a result, a tax has to be paid on the income earned. Capital gains can be defined as “investment income” derived from real assets such as property, financial assets such as shares, stocks, or bonds, or intangible assets like patents, trademarks, etc.

If you invest in an asset and get a profit out of its transfer or disposal, you will have to pay capital gains taxes on those earnings. However, there are various legal strategies to reduce your capital gains taxes.

Capital Gains on Property

The proceeds earned from the sale of a real estate property come under capital gains or losses. If the property is sold at a profit, then it is called capital gains. And if the property is sold at a value lower than its acquisition price, it is called a capital loss. Capital gains are considered as “income” and hence are taxable. The tax liability on capital gains from the sale of a property is called the capital gain tax on property. 

Read on to know in detail about what’s and how’s of capital gain tax on property.

What is capital gain?

The rise in a capital asset’s value when sold is referred to as a capital gain. A capital gain occurs when you sell an asset at a price greater than its acquisition price. Almost any asset you hold is a capital asset, whether it’s an investment such as a stock, bond, real estate, or something you bought for personal use except wearing apparel and furniture. 

Depending on the holding period of the asset, from the time of its acquisition to sell-off, the capital gains thus earned are categorised into “short and long-term capital gains.”

Short-term capital gains

Short-term capital gain is defined as capital gain made by an individual in lieu of the transfer of a short-term capital asset. Capital gains earned from the sale of a capital asset that has been held for less than 3  years from the date of transfer/ownership are called short-term capital gains. In the case of shares, this period of holding should be less than 12 months. 

Calculation of short-term capital gains on property

The short-term capital gain on a property is calculated using the following formula:

Short-term capital gain = Sale value of the property – (Cost of acquisition + Expenses borne in the process of selling the property + Costs incurred in asset i.e.. property improvement)

Long-term capital gains

Long-term capital gains result from the sale or transfer of a capital asset after 3 years (in the case of real assets like gold, property, etc.) or more than 1 year (in the case of shares or mutual funds) of its acquisition. Long-term capital assets are assets that have been owned by an entity or a taxpayer for more than 3 years since the date of the asset to his/her name. From the financial year 2017-18, gains on the sale or transfer of immovable assets like house properties, land, and buildings held for 24 months or more are considered long-term capital gains. In the case of listed shares (equity or preference), the holding period  has to be more than 12 months for the capital gains to be long-term. 

Calculation of long-term capital gains on property

The following formula is used to determine long-term capital gains:

Long-term capital gain = Final Sale Price – (Indexed acquisition cost + Indexed improvement cost + transfer cost)

Where:

• Indexed cost of acquisition = Cost of acquisition x  Cost inflation index of transfer year/cost inflation index of acquisition year
• Indexed cost of improvement =  Cost of improvement x   Cost inflation index of transfer year/cost inflation index of improvement year

It should be noted that the cost of the improvement is not applicable in calculating capital gains for shares, be it short-term capital gains or long-term capital gains. The scope of asset improvement is applicable to real assets and not financial ones. 

In some of the calculations for long term capital gain tax, the indexation is not required because of lower tax rates e.g LTCG tax on listed equity shares @10% without indexation.   

Tax on Capital Gains   

Now that we know how the short-term and long-term capital gains are calculated, we can turn the discussion toward the tax rate that these gains attract. 

Short-term capital gains tax – With respect to taxation, the short term capital gains are further categorised into two sets- 

1. Short-term capital gains covered under Section 111A – Short-term capital gains that fall under this section are taxed, at 15% with additional applicable surcharge and cess. 
2. Short-term capital gains not covered under Section 111A – Short-term capital gains other than those under Section 111A are taxed based on the normal income tax slab rate for the individual.

Long-term capital gains tax – Usually the long-term capital gains are taxed at 20% along with an additional surcharge and cess. However, in some special cases, they are charged at 10% with applicable surcharge and cess. 

This 10% concession is available in the following cases –

1. The sale of listed securities results in long-term capital gains and the gain amount exceeds Rs. 1,00,000
2. There is a long-term capital gain from the transfer of the following:

• Any security that is listed in a recognised stock exchange in India
• Any unit of UTI or mutual fund 
• Zero coupon bonds

Saving Capital Gains Tax on Sale of Property

Suppose you are planning to sell a property and are worried about the consequent applicable tax on the capital gains because you may have to shell out a significant amount of the income generated. In that case, you should be aware that you can reduce the tax liability. Discussed below are some of the exemptions you can tap into to reduce your capital gains tax liability on the sale of a property. 

Exemption for capital gains on residential property transfers – Section 54

Under Section 54 of the Income Tax Act, 1961, you can avail of tax deductions for the capital gains earned by selling a residential property if the capital gains are used to buy or construct a new residential property. It is important to note that this exemption is applicable only to long-term capital gains. Thus, the property has to be sold after 2 years (24 months) from the date of acquisition. Then the accrued gains will come under long-term capital gains and thus will attract an LTCG tax of 20% along with an additional surcharge and cess. This taxation can be exempted if the long-term capital gains are reinvested in a residential property, subject to some conditions, which are:

1. The exemption is available only to individuals and HUFs.
2. The proceeds from the sale of the property is reinvested in buying or building a maximum of two houses. 
3. If the gains from the sale of the property are reinvested in two residential properties, the tax deduction will be viable if and only if the capital gains on the sale of the property do not exceed Rs. 2 crores. 
4. The residential property where the capital gains are reinvested must be located in India. 
5. The new property must be purchased either before one year or after two years of the sale of the main property. 
6. If you are constructing a new residential property (and not buying it), the construction should be completed within three years of the sale of the main property. 
7. The entire amount of the capital gains has to be reinvested in buying or constructing the new residential property to get the whole capital gains tax exempted. For better clarity, let us explain this particular with an example –

Suppose Ms P sells a property and earns a long-term capital gain of Rs. 15,00,000. She reinvests Rs. 10,00,000 in buying a residential property. This Rs. 10,00,000 will be exempt from taxation. The remaining Rs. 5,00,000 will be taxed as usual. 

8. On the date of the transfer, the taxpayer should not own more than one residential house other than the one purchased for the purpose of claiming exemption under this section. 
9. The newly bought or constructed residential property has to be held for at least three years. If it is sold before three years, then the tax exemption benefits on the capital gains will be reversed. The profits earned on the sale of this new residential property along with the main property will also be considered short-term capital gains. 

Invest in bonds – Section 54EC

Investing the money earned from the sale of property in bonds within six months is one strategy to save on capital gains tax. Bond investments are tax-exempt as per the provisions of Section 54EC of the Income Tax Act of 1961.

Section 54EC of the Income Tax Act of 1961 provides that long-term capital gains are free from tax if they are invested in designated investment instruments within a specific time period. This exemption is applicable to both residential and non-residential properties. However, the exemption for long-term capital gains tax under Section 54EC is also subject to some conditions –

1. There is a minimum and maximum limit of investment that can be made in the prescribed bonds. Minimum – 1 bond worth Rs.10,000 and maximum – 500 bonds worth Rs. 50,00,000. The maximum limit of investment is capped at Rs. 50 lakhs. 
2. This exemption is available on bonds of that of specific issuers. Some of them are Power Finance Corporation Limited (PFC), Railway Finance Corporation (RFC), etc. 
3. These bonds must be held for 5 years (5-year lock-in period, earlier it was 3 years) and cannot be transferred to a third party. 
4. The enlisted bonds earn an annual return of 5-6% , which is taxable.
5. To get the tax exemption, the investment has to be made not only within 6 months from the date of sale/transfer of property, but also before the ITR filing due date.

Invest in equities of eligible companies – Section 54GB

According to Section 54GB, any capital gain derived by an individual or HUF from the transfer of a long-term capital asset that is residential property (a house or plot of land) is eligible for tax exemption if the net consideration price is invested in the subscription of equity shares of an eligible company prior to the due date of furnishing of return of income. 

However, this clause has been updated to allow an exemption for capital gains invested in qualifying start-ups. Thus, if an individual or HUF sells a residential property and invests the capital gains in 50% or more equity shares of an eligible startup, the tax on long-term capital will be deductible. However, these shares should not be sold or transferred within 5 years of their acquisition. 

Even a start-up making purchases like computers or other equipment for its business can also avail of capital gains tax exemption under this section. 

Deposit in CGAS account

Investing in the Capital Gains Account Scheme (CGAS) is another approach to reducing your capital gains tax on property. This strategy is appropriate for those who are unable to purchase a new home before filing their income tax returns. Looking for a suitable property, zeroing in on it, and arranging for the residual finance (apart from the reinvested capital gains) can be time taking. And the process of owning a property should not be done in a rush. You can instead invest your capital gains in a ‘Capital Gains Account’, as capital gains deposits made in this scheme are tax exempt as it would be in case of re-investment. 

The investment period for this scheme is three years, which will allow you to save money for the purchase of your own home. However, the individual must be enrolled in this scheme before filing their income tax returns. 

Conclusion

The taxability of capital gain is determined by its nature, i.e., whether it is short-term or long-term. To establish taxability, capital gains are divided into two categories: short-term capital gains and long-term capital gains. In other words, the tax rates for long-term and short-term capital gains differ.

Similarly, the computation provisions for long-term capital gains and short-term capital gains differ. Under the pertinent parts of the Income Tax Act, a taxpayer may claim an exemption or avail a benefit from the long-run capital gains tax using the ways that have been discussed above.

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