How To Save Tax On Long-Term Capital Gains

The Budget in 2018 has brought the focus back on Long-Term Capital Gains (LTCG). If you didn’t know, LTCG on equities that is more than Rs. 1 lakh will be taxed at 10% from the next financial year 2018-19.  This applies to both shares and equity Mutual Funds. There’s nothing much that can be done to save on LTCG tax in case of equities. However, there is hope for those who have to pay LTCG tax on property transactions.

Property is a preferred investment for many in India. When a property is bought and then sold for a profit, LTCG tax has to be paid. The amount of tax that you pay, however, will depend on a couple of factors. One of these is the amount involved in the sale and purchase of the property. As this amount generally tends to be quite high, the resultant tax amount will also be high. Since this can be a burden to investors and to encourage investments in properties, the Government of India has laid down several alternatives for getting tax exemption for LTCG under the Income Tax Act.

Short-Term Capital Gains (STCG) & LTCG

Planning your capital gains right is an important part of selling a property. But you have to understand certain terms before that. Two important terms that you need to know before computing the net tax liability for your capital gains are STCG and LTCG. When you sell a property that’s been held for 3 years or less, it attracts STCG tax, when sold at a profit. Similarly, if you sell a property that’s been held for more than 3 years, you will pay LTCG tax.

Additional Reading: Avoid Real Estate Scams To Reap Rich Returns

In case of an STCG transaction, the gain is added to your income and taxed as per the income tax bracket you fall under. For instance, if a taxpayer falls under the tax slab of 30%, the STCG will also be taxed at the rate of 30%. This amount is not eligible for any kind of exemption.

On the other hand, if the taxpayer is liable to pay the LTCG tax, there are several provisions available that can help reduce the tax burden arising from these transactions. Some of these are indexation benefits, lower tax rate and deductions available as per the Income Tax Act.

To reduce the tax burden, indexation takes into account inflation in its calculations by using the Cost Inflation Index. The tax rate of 20% on LTCG brings down the amount of tax payable significantly when compared to STCG tax (which is 30%). Apart from this, there are several exemptions and deductions available to reduce the LTCG tax burden of a tax payer. These deductions are available in the following circumstances:

• LTCG arising on the sale of a residential unit and investment made in a new residential unit.
• LTCG arising due to the sale of an agricultural land and investment made in new agricultural land.
• LTCG arising on the compulsory acquisition of land and buildings of an industrial undertaking and investment made for the purchase of land or building in order to shift or re-establish the industrial undertaking.
• LTCG arising due to the transfer of machinery or plant or building or land of an industrial undertaking situated in an urban area and an investment made for machinery or plant or building or land for the purpose of shifting the industrial undertaking to any area other than an urban area.
• LTCG arising on sale of an asset other than a residential unit and investment made in a residential unit.

How to save LTCG tax

Investment in residential property within a specific time frame (Section 54/ 54F):

As per income tax provisions, LTCG arising from the sale of a capital asset (residential or non-residential property) is exempted under Section 54/54F, if the net sale proceeds are invested in the purchase or construction of a residential property, subject to the following conditions:

Condition (i): The investor/seller should use the funds from the capital gains to purchase a new residential house within 1 year before or 2 years after the transfer date (sale/transfer of the original property).

Condition (ii): If the investor intends to invest the money in an under-construction residential property or construct a residential property, the construction needs to be completed within 3 years from the date of transfer of the original property.

Additional Reading: 5 Localities In Mumbai That Will Make Your Real Estate Investment Boom

Condition (iii): The investor should not own more than one house (other than the new house) on the date of sale or purchase or should not construct any residential house (other than the new house) within a period of three years, after the sale date.

Condition (iv): The investment in new residential property has a lock-in period of three years. If the new property is sold within a period of three years, the exemption claimed with respect to the old property shall be revoked and the capital gains will become taxable.

Condition (v): If the amount invested for buying a new house is less than the capital gains, then the maximum amount of tax exemption will be restricted to the proceeds from LTCG invested for buying a new house. In other words, the maximum exemption cannot exceed the amount of LTCG made. The balance amount of LTCG (after investing in new property), if any, is taxable at 20%.

Condition (vi): As per the Union Budget for FY 2014-15, for availing the benefit of LTCG tax exemption, the investment should be made only in one residential house property situated in India, not abroad.

Deposit funds under the Capital Gains Account Scheme (CGAS):

To avail tax benefits, the capital gain should be re-invested in a residential property before filing the income tax return for that year. If you are unable to find the right property or you invest that money in another property before the due date (usually 31st July) of filing your tax return, then the unutilised LTCG can be deposited under the Capital Gains Account Scheme (CGAS). Taxpayers can avail exemptions under the CGAS only when the amount of capital gain, or net consideration, is deposited by the last date for filing the income tax return.

There are 2 categories of CGAS:

Deposit Account Type A: All deposits in this account are in the form of savings. This account is suitable for taxpayers who want to construct a house in tranches as withdrawals are permitted according to the provisions of the scheme.

Additional Reading: Real Estate Investing 101

Deposit Account Type B: This account is similar to a term deposit as it is payable after a fixed time duration. The depositor can opt for cumulative or non-cumulative deposits. Withdrawals from this account can be made only after a stipulated duration.

The capital gains account, however, is only a temporary arrangement to park your funds for 2-3 years. The withdrawals from these accounts should be made for purchasing/constructing a residential property only.

Investment in bonds (Section 54 EC):

LTCG arising from the transfer of any long-term capital asset are exempt under section 54EC. For availing this exemption the investor, within a period of 6 months of the sale, should invest the capital gains in notified bonds issued by the authorities such as National Highways Authority of India (NHAI) or Rural Electric Corp. (REC) Ltd for a minimum period of 3 years. This is restricted to Rs. 50 lakh per financial year. These bonds are also known as capital gain bonds.

An investor who wishes to claim the exemption from LTCG tax has to invest the LTCG in capital gain bonds within 6 months from the date of sale (of property) or before the due date of filing income tax return (usually 31st July), whichever is earlier.

The interest rate offered on these bonds was 5.25% as of 2017 and you have to pay taxes on the interest income from these bonds.

Tax treatment for capital gains is different from taxation of regular income. It is important for an investor to be aware of the computation and the availability of various options to save on tax liability. If investing in a residential property is your choice, funding a part of your purchase using Home Loan will help you save more taxes.