Selling a house is a huge task in itself. More so the seller will be charged a tax on the capital gains, when there is a gain on the sale of a house and need to find out ways to reduce tax liability.
Short term or long term capital gains
Capital gains can be classified as short term or long-term capital gains.
If two years have passed, between the date of purchase and sale of a fixed capital asset, then, the gain from the sale will be termed as a long-term capital gain. If less than three years have elapsed, the gain will be treated as a short-term capital gain.
The differentiation between short and long-term capital gains is important because both of these are treated differently in terms of taxation. The tax rates and tax benefits which are applicable on the reinvestment of these two types of gains vary.
Long-term capital gain is taxed at the rate of 20%, plus a surcharge of 3%, if the sale fulfils certain conditions.
If a property that was gifted, or inherited, is sold, one is still be liable to pay capital gains tax on it. The cost of purchase here is calculated on the basis of the cost to the previous owner, indexed to the year of purchase.
How can one save on Capital Gains Tax while Selling Property?
The person receiving the benefits of a profit from sale can choose to invest it in the given time frame and save himself from taxation on Capital Gains. There are several provisions in the Income Tax Act, which helps one to reduce or avoid paying tax on the gains accrued from the sale of a house.
Long term capital gains stand exempted from taxation (under Section 54 of the Income Tax Act, 1961) for individuals and Hindu Undivided Families on the sale of a house property if:
- The capital gains are used to purchase or construct another house.
- The new house is purchased one year before or two years after the sale of the old house.
- The new house is constructed within 3 years after the sale of the old house.
- Only one additional house property is purchased / constructed.
- The property being bought / developed is within India’s national borders.
- The new house is not sold for minimum 3 years after taking possession of it. One cannot avail of the exemption under Section 54, if the house is sold after holding it for less than three years
- If the cost of the new property is lesser than the sale amount, the exemption then only applies proportionately. The remaining money can be re-invested under Section 54EC within 6 months of sale in some specific bonds.
Capital Gains Account Scheme:
If one cannot construct a house immediately after benefitting from a capital gain (but intend to do so sometime in the near future), then the profit amount can be kept in any public sector bank under the Capital Gains Account Scheme (CGAS). The new house can be purchased or constructed, by withdrawing the amount from this account within the specified time limit.
If the property is not brought in 3 years then the capital gain amount will be taxed as a long term capital gain (at 20% plus a 3% cess).
Investing in specified bonds (under 54EC) to reduce capital gains tax on sale of property:
Section 54EC provides for exemption on capital gains tax, if the amount is invested in the bonds of Rural Electrification Corporation (REC) or the National Highways Authority of India (NHAI). The investment must be made within six months from date of sale of the property. Up to Rs 50 lakhs can be invested in these bonds per individual in a financial year, which have a tenure of five years and are redeemable after five years as against the earlier three years as per the Proposed amendment under Section 54EC vide the budget. Rate of Interest is 5.65% taxable.
Other options for saving tax on capital gains other than Bonds :
Real Estate: One can reinvest the capital gain in the real estate. However the market for real estate at present is close to its bottom. In the long term, say, 5 years from now, putting together rental yield and price appreciation, one can expect a return of 9-10% from real estate. However, a major problem with real estate is that it is also not easy to liquidate and its transaction costs can be high.
Fixed Return Options: The other option to invest may be other fixed-return options, like the Government of India 7.75% Savings (Taxable) Bonds, 2018. But returns from these bonds after factoring in the tax implication will not be able to match that of the section 54EC bonds. Besides, the maturity period of these bonds is 7 years.
Pay Long-Term Capital Gains Tax or Buy Sec 54EC NHAI/REC Bonds?
Though bonds help in avoiding capital gains tax, the question now is whether it is worth investing in these or should one pay the tax.
When should one opt to invest in 54EC bonds ? As discussed previously, long-term capital gains from transfer of capital assets, if invested in capital gain bonds specified under section 54EC of the Act—provide exemption from tax and offer a rate 5.25% a year. However, if one does invest in 54EC bonds, then one needs to take into account the complete lack of liquidity for the entire period of 5 years. So, if one wants to avoid market risk (as in case of mutual funds) and if capital gains from sale of assets are not allied to near-term goals, one may prefer to choose to invest in 54EC bonds.
When should one opt to pay tax on capital gains ? In case one decides to pay the LTCG tax, it will be at the rate of 20.6% (from AY 2019-20 it will be 20.8%, due to higher cess) but one will get the advantage of indexation. Client goals are an important factor in determining which option to choose. If the person has a longer investment horizon and a higher risk appetite, or if he/she needs even a part of the money for near-term goals, one can consider paying the tax on the capital gains and evaluate other investment options. A detailed analysis on whether to invest in capital gains bonds or pay the tax is covered in house here
Buying a Second Home? Tax Considerations
There is a growing percentage of the Indian population that owns more than one house. In fact, this privilege that was once reserved only for the rich has now been extended to the middle class, thanks to the increase in affordable housing. Tax breaks are the best part about getting a second home. There are a few tax benefits available on the second home which are mentioned below.
- This will include the interest payment benefits that are claimed for the first home. Interest deduction is capped at Rs 2,00,000 for a self-occupied property. However, if it is let out or vacant (deemed to be let out), the limit on interest offset is restricted to Rs 2,00,000 from one’s taxable income as per Budget 2017One will be exempt from paying wealth tax (for having more than one property in his/her name) if the second house is let out. However, the house should be let out for a minimum of 300 days in a year.
- To make it even more advantageous, one should treat the property with higher annual value as self-occupied. This way, the taxes get reduced.
- When a house is not self-occupied and purchased for investment, it is deemed to be let out and notional rent has to be paid on the same.
Debalina Roy Chowdhury