You can invest the proceeds in capital gains bond or reinvest in another residential property.
Property values have shot through the roof. There are many who are, hence, investing in property these days. Property may be sold either to buy another one or to book a profit, when the valuations have become attractive.
Vikram was doing the latter. He was getting transferred out of Mumbai, to his home city, Delhi. He had bought a house in a Mumbai suburb, about six years earlier. He is now interested in selling it, as he plans to settle in Delhi and he even has a buyer for it. He is seriously considering that, but wanted to know a bit about the tax options surrounding the sale of the property.
When a property is sold and the profits are retained, taxes have to be paid. In property transactions, normal income tax does not apply; capital gains taxes do. For properties sold after three years of acquisition, long-term capital gains (LTCG) tax applies. Short-term capital gains (STCG) apply for properties sold less than 36 months after being bought. These are at the applicable tax rates for an individual. LTCG tax is 20 per cent, after applying the cost inflation index. The index is applied to compensate for the effect of inflation, over time.
OPTIONS
He has the option of paying the tax computed after indexation at 20 per cent and invest in a good instrument and earn good returns. If he invests in equity mutual fund schemes, for instance, he will be able to get good double-digit, tax-free returns. This is a good option, too, as one need not invest in low-yielding propositions for the sake of saving tax or be forced to invest in another property. But then, many people want to save taxes at all costs.
If Vikram does not want to pay tax, he can also invest the gains in capital gains bond (under Section 54EC of the Income Tax Act). These bonds are issued by entities like Rural Electrification Corporation (REC), National Housing Bank (NHB), and so on.
| TAX MATH |
| * If the house is sold within three years of purchase, you need to pay short-term capital gains tax |
| * The proceeds under STCG are added to your income and taxed as per your slab |
| * If you sell the house three years after the purchase, you need to pay long term capital gains tax |
| * This is taxed at 10 per cent of the gains or 20 per cent with indexation benefits |
| * You can save LTCG by investing in capital gain bonds that REC or NHB issues |
| * The return on these bonds is around six per cent with a lock-in of three years |
| * A person needs to invest in these bonds within six months of selling the property and can only invest up to '50 lakh in one financial year |
There is a six-month window to purchase these bonds, once you have sold the property. Currently, they yield about six per cent and have a lock-in period of three years.
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The problem in this case is that though Vikram would be able to save tax by investing in these bonds, he is also potentially losing, as the interest rate on these bonds is low. In addition, the income from these bonds is taxable. And, the maximum one can invest in a capital gains bond is Rs 50 lakh for a financial year. However, if the transaction has happened after October 1 of the year, then the window flows to the next financial year, too, allowing one to invest up to Rs 1 crore.
Vikram has another way of saving tax. He can buy another property for the value of capital gains. This comes under Section 54 of the I-T Act. Such a property can be bought a year prior to the sale or within two years after. In case of construction of property, the time allowed is three years from the date of sale.
In the meanwhile, the gains need to be deposited in a capital gains deposit account before the date for filing returns. Any unutilised amount of this capital gains after the stipulated period will be charged to income tax in the ‘previous year’ at the end of the three year period. So, part-utilisation is possible.
Vikram also wants to know if he can sell his house in Mumbai and buy another in Delhi, the city he will reside after the transfer. It is permitted to buy a property anywhere in the country.
There is a bit of ambiguity on whether one can invest the proceeds in one residential property or more than one. From a strict reading of the clauses, it is safe to assume the proceeds need to be invested in a single residential property.
Vikram's friend, Gaurav, has another problem. He has sold a commercial property and would like to save the capital gains tax.
This is possible, too, under Section 54F of the I-T Act. This is applicable for capital assets other than a residential property. So, a person can save capital gains on gold too, which is treated as a capital asset.
There is one major difference as compared to the sale of residential property and the capital gains treatment thereon. Here, Gaurav will have to invest the entire proceeds from the sale in a residential property.
The time frames for investment remain the same as in the case of sale of residential property. This, however, will work only if he does not own more than one residential house on the date of transfer of the original asset, excluding the one he would purchase to save capital gains tax.
It is now up to Vikram to decide if he wants to buy a property or pay the tax and invest elsewhere.
The writer is a certified financial planner