Saving capital gains on sale of property
Any profits you earn from the sale of a property will be classified as capital gains and are liable to be taxed. Here are the ways you can avoid paying anything on your gains.
Property deals in India, more than much of the world, are a mess. If you’re expecting a smooth transaction, you’re being too optimistic. One aspect you shouldn’t forget while being in this mess is taxation, if you’re the seller. This is because any profit on the transaction is liable to capital gains tax. But it’s not something you necessarily have to pay. Here’s what you can do:
What is capital gains tax?
A capital gain is profit earned on the sale of capital assets – shares, property and mutual funds. The Income Tax Office taxes these gains according to the time for which the assets are held. For property, if the property is held for less than three years, it is classified as a short-term capital gain. Anything longer than three years is a long-term capital gain. The former is taxed as per your income tax slab, while long-term gains are taxed at 20% with indexation.
How much tax will you be paying?
This depends on your holding period. You’ll pay tax at your tax slab if you’ve held it for less than three years and 20% with indexation if you’ve held it longer than three years. Unless you’ve made a very high capital gain in a very short period, it is always better to pay long-term capital gains, as indexation allows you to adjust for inflation.
Here’s how it works:
Let’s consider a property bought for Rs10 lakh in 2000 and sold in 2013 for Rs30 lakh.
To factor in inflation, we need also to find the cost inflation index (CII) in the year of purchase and sale. You can find these values here. It only began in 1981; if the property is older than this, you still need to consider the 1981 value as the CII in the year of purchase.
The formula is:
Indexed purchase price = (Purchase price x CII for year of sale)/CII for year of purchase
Therefore, the indexed price is Rs10 lakh x 939/406.
This works out to Rs23.05 lakh.
Therefore, your capital gains would be calculated on Rs6.95 lakh (Rs30 lakh – Rs23.05 lakh). In this case, your tax liability would be Rs1.39 lakh, as opposed to Rs2 lakh (10%) without indexation.
How to avoid it completely
You could potentially avoid your entire tax liability on these gains. For this to be possible:
1. The asset you are selling must have been held for the long-term.
2. You must invest the capital gain in a residential property, which should have been purchased a year prior to the sale or two years after. The exemption can be claimed under Section 54 of the IT Act.
3. If the new residential property is yet to be constructed, you have a period of three years from the date of sale to take possession of it. This property must be held for three years.
4. Alternately, you can invest in bonds issued by National Highway Authority of India or Rural Electrification Corporation. The maximum amount of exemption is Rs50 lakh, to be claimed under Section 54 EC. The amount will be locked in for three years.
5. If you don’t buy a property or invest in the bonds before the time comes to file your returns, you have to open an account under Capital Gain Account Scheme. Any withdrawal from this account should be toward the above-mentioned investments for you to continue to enjoy exemption.