January 30 , 2013
Whenever you sell real estate and make money on it you are liable to pay capital gains tax on it. Income from capital gains is to be declared while filing Income Tax Returns.
Short term capital gains tax applies when property is sold within 3 years of buying it. This is charged at the marginal tax slab. For instance if you come under 20% tax slab and you sold a piece of property last year for Rs 35 lakhs which you had bought for Rs 25 lakhs in 2009 your short term capital gains tax will be Rs 2 lakhs.
Long term capital gains have better tax treatment. They are charged at 20% with the benefit of indexation of cost of acquisition. If the property were bought in 2005 for Rs 25 lakhs and sold in 2011 for Rs 40 lakhs the indexed cost of acquisition would be:
Actual cost x (Cost Inflation for 2011/Cost Inflation for 2005) which would be 25,00,000 x (785/497). Cost inflation index is computed by government tax authorities for every year. Look it up in the Ready Reckoners section of Property page. Thus long term capital gains tax on this transaction would be Rs 10,000.
How to save on long term capital gains tax
You can save on long term capital gains tax by investing the gain in a residential house or specified government bonds. This is possible under three sections of I-T Act that is section 54, section 54 F and section 54 EC. Brokerage, stamp duty, registration charges, transfer charges, etc incurred during the purchase can be added to the cost of the house.
Under section 54 if the capital asset under consideration is a residential property you can invest the capital gain amount in another residential property within 2 years of or 1 year prior to selling the first one. Or you can build a house within 3 years of selling the old one to get this benefit. Maximum amount that can be saved is equivalent to amount of capital gain. If the new house is sold before 3 years capital gains tax will apply. If the amount is not used to buy/create house by due date of filing I-T returns the amount should be deposited in a Capital Gains Deposit Account.
Section 54 F
Similar to section 54, when the long term capital asset under consideration is not a residential property, you can still set off the tax by investing it in a residential property under section 54 F. However if the entire amount is not invested it will not all be exempted from tax. In this case amount of exemption is calculated as Capital Gain*(Invested Amount/Net Sale Amount). Also you cannot own more than 1 residential property during the time of selling property on which you are claiming LTCG tax exemption under section 54 F.
Section 54 EC
You can still save up to R 50 lakhs on long term capital gains tax on any kind of capital asset including property (both residential and non-residential) even when you do not want to buy property. You can be exempted by investing the amount in REC or NHAI long term bonds with minimum lock-in period of 3 years under section 54 EC. This should be done within 6 months of sale. If the bonds are sold or pledged for loans before 3 years of investing in them capital gains tax will be charged.
What happens if you sell the new property before 3 years?
If you sell the house property you claimed LTGC on, before 3 years of buying it, the buying price of it while computing STCG tax will be reduced by the amount of LTCG you had claimed on it. Suppose you sell a house for Rs 30 lakhs in 2010 which you had purchased in 2005 for Rs 10 lakhs. You claim Rs 20 lakhs exemption on LTCG tax under section 54 by buying another house in 2010 which cost you Rs 40 lakhs.
Now suppose you move to another city so you sell this house for Rs 55 lakhs. STCG tax will apply on this sale. Capital gains would be Rs 35 lakhs which is equal to Rs 55 lakhs – (Rs 40 lakhs – Rs 20 lakhs). You end up paying tax on Rs 20 lakhs more as capital gains if sold after 3 years would be Rs 15 lakhs which is Rs 55 lakhs – Rs 40 lakhs. And remember that STCG tax rate can be higher than LTCG tax rate if you are in the higher tax brackets.