Income Tax | Capital Gains: How to save income tax on capital gains from selling a house

Tax on capital gain is triggered when a person transfers (by way of sale, exchange, conversion, relinquishment of right) any capital asset (such as house, land, building, equity shares, mutual funds etc.) and derives profit from such transfer. The seller of a property is liable to pay income tax if the sale of property has led to capital gains. Even though the seller cannot claim common deductions such as sections 80C, 80D etc. to reduce their tax burden, there are certain other ways to save income tax on capital gains derived from sale of property. Here is how you can do it.

Types of capital gains

The Income-tax Act, 1961 categorises capital gains into two types, ‘long-term’ and ‘short-term’, based on the period of holding of such capital assets.

For any property, (such as house, land and building) to be classified as a long-term capital asset, the said property should be held for more than 24 months from the date of its acquisition, else it will be considered as short-term capital asset. If the property is transferred before the expiry of 24 months, the gains would be short-term capital gain (STCG) or loss. If sold after 24 months, it will result in long-term capital gain (LTCG) or Loss.

Further, LTCG would be subject to tax at 20% with indexation benefit and STCG will be taxed at income tax slab rates applicable to the taxpayer.

How to save income tax on capital gains from house property

  • Tax exemption under section 54 by investing in another residential house

Any individual taxpayer can claim exemption under this section if capital gains are derived from sale or transfer of a house. The tax exemption can be claimed if the house property sold resulted in long-term capital gains. Those gains must be invested in another residential house property in India. The tax exemption available would be lower of the following amounts:

1. Investment made in the new residential house property; or

2. Amount of capital gain

To claim tax exemption under section 54, the new house property must be purchased within 1 year before or 2 years after the sale of the old house property. In case of construction, the new property must be constructed within 3 years of sale of old property.

If capital gains are derived from compulsory acquisition of house property by the government, the period of buying or constructing new house will be determined from the date of receipt of compensation.

However, if the new house property is sold before the lock-in period of 3 years, the tax exemption under section 54 will lapse and such amount will be reduced from cost of acquisition of the new property sold and the capital gains would accordingly be computed. For instance, a taxpayer claims an exemption of Rs. 20 lakhs by way of investing Rs. 60 lakhs in a new property. However, if he sells the property before the expiry of lock-in-period of 3 years, the cost of the new property would be treated as Rs. 40 lakhs (Rs. 60 lakhs less Rs. 20 lakhs) for the purpose of computing capital gains, instead of the original cost of Rs. 60 lakhs.

Tax exemption under section 54 can be claimed only in respect of house property purchased/constructed in India. Accordingly, no such tax exemption can be claimed in respect of house purchased outside India.

Usually, tax exemption is available for one-house property. However, there are certain exceptions. From FY 2020-21, tax exemption is available for two-house properties if the amount of capital gains does not exceed Rs 2 crore. This option can be exercised by the taxpayer only once in his entire lifetime.

  • Tax exemption under section 54EC by investing in specified bonds

Individuals can claim tax exemption under section 54EC with respect to LTCG from sale of any property (residential and commercial). They are required to make investments in bonds that are notified by the government to claim tax exemption. Such specified bonds have a lock-in of 5 years. If the bonds are sold before the expiry of 5 years, then the tax exemption will not be available.

To claim tax exemption, investment in specified bonds is required to be made within a period of 6 months from the date of sale/transfer of such property. The quantum of such tax exemption shall be lower of the following:

1. Capital gain; or

2. Amount invested; or

3. Rs. 50 lakh

Currently, specified bonds under which the taxpayer can invest are Rural Electrification Corporation (RECL), Indian Railway Finance Corporation (IRFC) & Power Finance Corporation Ltd (PFCL).

  • Tax exemption under section 54G by investing in specified company

This section provides tax exemption to individual taxpayers on LTCG derived from sale of house property. The tax exemption can be claimed if net sale consideration received on sale of property is invested in equity shares of an eligible specified company (usually a startup). Further, the company must utilise the money to purchase certain plant and machinery, office equipment (like computer and computer software, etc.) or any vehicle for official use within a period of 1 year.

Such investment is required to be made on or before the due date of income tax return filing. Hence, if the house is sold in February 2022, the investment in the startup/company must be made on or before July 31, 2022. Further, in case where the entire net sale consideration is not utilised for the purpose of investment, the exemption allowed will be proportionate to the amount so invested.

Other things to keep in mind to claim capital gains exemption

Due to practical difficulties, at times it is not possible for taxpayers to make the investments aforementioned within the specified time period. Thus, to redress such concerns, the Capital Gains Account Scheme (CAGS) was introduced.

Taxpayers who could not make the investments within the prescribed timeframe can deposit the money in CGAS account to avail the tax exemption. CAGS account can be used by taxpayers only if they will claim tax exemption by investing capital gains in another house property or company/start-up.

CGAS deposit is required to be made on or before the due date of ITR filing (July 31) or before the actual date ITR is filed, whichever is earlier. The amount deposited in this scheme can be withdrawn any time for specified purpose of investing in another residential property or in equity shares of eligible specified company. However, if the taxpayer fails to invest from CAGS within the prescribed time limits i.e. 2 years in case of buying a new property or 3 years in case of construction of new property, then capital gains will be taxable.

(The writer is the founder of RSM India – a tax consulting group.)

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