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How to save capital gains tax on property sale in Real Estate ? And What is capital gain tax?

Property sales are usually high-ticket deals and attract huge tax on the profit generated. The Indian government provides multiple benefits to help sellers lower the Long Term Capital Gains (LTCG) tax. However, in Budget 2023-24, the Centre capped the residential reinvestment limit to Rs 10 crore. Let’s look at how can you save capital gain tax on a sale of a residential property post this change.

Every property transaction attracts taxation, and capital gains tax is one such kind levied on property sellers in India. The government levies this charge on the number of years the owner possesses the property before putting it out for sale in the market. The tax is applicable on the revenue generated by the seller on the property transaction. Although there was previously no upper limit on the maximum deduction that could be claimed while reinvesting the capital gain into a residential property, the Union Budget 2023-24 has introduced a capping of Rs 10 crore from April 1, 2023. To help you understand it better and equip you with ways to save capital gains tax on a sale of a residential property, here is a breakdown for you.

What is capital gain tax?

The first step is to understand what capital gains mean. As the name suggests, these are capital assets like properties or securities. These gains are further divided into short-term or long-term based on the holding period of the asset.

What is short-term capital gain tax?

If you sell the property within two years, the profit earned from its sale will be considered short-term capital gains. Such gains are added to your taxable income and are taxed according to the applicable income slab. There are no exemptions available to save Short Term Capital Gain (STCG) tax.

What is long-term capital gain tax?

If immovable assets such as land, house property, and building are held for two years or more and then sold with a profit, then the profit earned from its sale would be considered a long-term capital gain. You will have to pay 20 percent tax on it, which is known as Long-Term Capital Gains (LTCG) Tax.

Impact of the Union Budget 2023-24 on LTCG tax

Before we break down the Union Budget 2023-24 announcements concerning the LTCG tax, it is imperative to understand how the tax deduction worked till the Financial Year 2022-23, which ended on March 31, 2023. In this tenure, when a residential property was sold, the seller had the option to reinvest the amount to buy another house to avail LTCG benefits. The entire amount earned by selling off a house was allowed for reinvestment to buy another housing unit. There was no upper limit on this reinvestment amount, and it was tax-free.

However, in the Budget for the current Financial Year (FY) 2023-24, Finance Minister Nirmala Sitharaman added a limit to the same arrangement. Starting April 1, 2023, when a homeowner sells off a house and reinvests that amount into another residential property, the tax benefit is limited to Rs 10 crore. This means that if the reinvestment amount is up to Rs 10 crore, it will not be taxed. For any amount above Rs 10 crore, a 20 percent tax will be applied under Sections 54 and 54F of the Income Tax Act. The Rs 10 crore capping is applicable to the Capital Gains Account Scheme also.

How to compute short-term capital gains?

Step 1: Calculate the full value of consideration (FVC), which refers to the sale value of the property or value adopted by the stamp duty authority whichever is higher

Step 2: From this full value, deduct the cost of acquisition along with the cost of transfer and cost of improvement

Step 3: The final amount will be short-term capital gain.
Short-term capital gain= FVC – (cost of acquisition + cost of transfer + cost of improvement)

How to compute long-term capital gains?

Step 1: Compute the full value of consideration accruing or received

Step 2: Deduct the indexed cost of acquisition, indexed cost of transfer, and indexed cost of improvement from full value consideration

Step 3: Deduct exemptions provided under Sections 54, 54EC, 54F, and 54B

Long-term Capital Gains = FVC accruing or received – (indexed cost of acquisition + cost of transfer + indexed cost of improvement + deductible expenses from full value for consideration)

Note: Indexed cost of acquisition= cost of acquisition X cost of inflation index of the acquisition year/cost of inflation index of the transfer year

Indexed cost of transfer= the brokerage paid for arranging legal expenses incurred, deals and cost of advertising, among others

Indexed cost of improvement= cost of improvement X cost of inflation index of the improvement year/cost of inflation index of the transfer year

Cost Inflation Index is declared every year by the government. This value is used for calculating capital gains on long-term assets.

How to save capital gains tax on sale of residential property?

As real estate transactions are generally expensive in nature, the tax calculated on a property sale can be a huge amount. In order to reduce or eliminate the payable LTCG tax, follow the below steps-

• A known way to save tax on the money earned by selling a home is to re-invest it into buying or constructing another residential unit
• A simple way to do this is to select a property beforehand so there is not much delay in utilising the funds
• Another way to save capital gain tax on property sale is to invest in the Capital Gains Account Scheme, 1988
• Those interested can open a capital gains account in authorised Indian banks
• Sellers can also direct their funds towards capital gains bonds issued by the Central government
• This provision can be availed at a select few public sector financial institutions

Purchase or construct a residential property

Under Section 54 of the Income Tax Act, 1961, an individual selling a residential property can now make use of tax exemption of up to Rs 10 crore on long-term capital gains if such gains are used to purchase or construct a residential property. Remember, this exemption is only applicable to long-term capital assets (in our case, immovable properties with a holding period of more than two years).

The following conditions need to be followed to obtain this exemption:

• The seller must purchase a residential property either one year prior to the sale of the original property or two years after the sale of the original property
• If you are constructing a house using capital gains, then the construction of the same should be concluded within three years from the date of sale of the original property
• The new residential property has to be located in India
• The exemption will be taken back if the newly purchased or constructed property is sold within three years of its purchase/construction

According to the Finance Act, 2019, with effect from Financial Year 2019-20 (FY 2019-20) – corresponding to Assessment Year 2020-21 – the capital gain exemption under Section 54 has been made available for the purchase of up to two residential properties in India. It still holds true, and the Rs 10 crore deduction is applicable even if the seller reinvests in more than one housing unit. The bottom line remains that the total reinvestment amount must remain within Rs 10 crore, and any amount exceeding the capping shall be taxed at 20 percent.

Deposit the funds in a capital gains account

Identifying a suitable property to re-invest your capital gains into, arranging all of the required funds and getting the documentation in place can take some time. Accordingly, if you have not been able to re-invest your capital gains into a new property until the date of filing your income tax returns, then you may invest these gains in a ‘capital gains account’ in any of the branches of authorised banks (excluding rural branches of such banks) such as Bank of Baroda, as according to the Capital Gains Account Scheme, 1988. This deposit can be availed as an exemption from capital gains for up to Rs 10 crore. In case the capital gain amount is more than Rs 10 crore, it will be taxed at 20 percent.

In case the deposited amount is not utilised within the specified period of two years (in case of purchase of new residential property) or three years (in case of construction of a new residential property), then, the deposit will be treated as short-term capital gains in the year within which the specified period lapses.

Invest the funds into capital gain bonds

If you do not want to re-invest your capital gains earned from the sale of your property into a new residential property and do not want to construct another one, you can invest your profits in ‘Capital Gain Bonds’ under Section 54EC of the Income Tax Act. These are also known as ‘54EC bonds’ and are one of the most popular ways to save LTCG Tax.

A few conditions:

• The minimum investment into 54EC bonds is one bond amounting to Rs 10,000, and the maximum investment is 500 such bonds totalling Rs 50 lakh
• Eligible bonds under Section 54EC are issued only by Power Finance Corporation Limited (PFC), National Highways Authority of India (NHAI), Rural Electrification Corporation Limited (REC), and Indian Railways Finance Corporation Limited (IRFC)
• These bonds come with a lock-in period of five years (effective since April 2018) and are not transferable to another person
• 54EC bonds offer a five percent annual interest rate. However, this interest is taxable
• The investment into these bonds must be made within six months of selling the property. In addition, the investment has to be made before the tax filing deadline.

The associated risk factor is minimal since these bonds are backed by the Government of India. Also, they allow you to save tax whilst earning interest income.

As you can see, the Income Tax Department has provided excellent options for you to save long-term capital gains tax. It would be prudent to spend some time thinking about your personal finance goals before making such a decision. You can also speak to financial experts about such investments to take into account the implications of the FY 2023-24 Budget announcements.

Frequently Asked Questions :- capital gains tax

How do I avoid capital gains tax on property sale?

If the sale occurs after 24 months of the purchase of the property, one can avoid paying the STCG tax. If you are holding the property for more than five years, you need to invest the gains to buy a new property.

What is the rate at which LTCG tax is imposed on real estate sales?

In India, the seller is required to pay LTCG tax on the sale’s profit at a rate of 20 percent.

What happens if the capital gains tax is not paid?

The Income Tax office can charge hefty penalties in case of negligence and may take further discretionary action depending on the magnitude of the situation.