When selling a property, make sure you are aware of the capital gains tax provisions to know exactly what your liability is
- Use indexation to reduce your capital gains liability
- You could use the gains to buy another property and benefit from the available tax savings
- You can invest in capital gains bond under Section 54EC to sett of the gains
It is not often that one tends to sell a property. But, when one does – the implications of capital gains set in. Importantly – the long term capital gains tax on the property is levied at the rate of 20 per cent and the short term capital gains tax add up to your taxable income. There are ways to save this tax outgo when you have sold it, which can reduce your tax liability from the sale of the property. Here are five ways in which you can reduce your capital gains tax liability from the sale of a property.
You can use indexation when calculating capital gains. The cost inflation index depicts the yearly increase of the inflation. Using this index, you can also inflate the cost of property with the rise of inflation. It means if cost inflation index rose from 500 to 700 in three years, the real cost of property can be increased from 50 lakh to 70 lakh in the same period. It also means that, if the price of property increases corresponding to the cost inflation index. You are not making any profit in real sense. This is how inflation eats up the appreciation of our investment.
In order to get the real current purchase value of the property you should inflate it corresponding to the cost inflation index. And, because of the inflated cost of the property, the capital gains reduce. It means you have to give less capital gains tax. Income tax department releases the cost inflation index annually. For this index the base year was 1980-81, which has been changed to 2001-2 now on as the new base year with 100 as the base. The calculation of capital gain may appear to be simple, with capital gains being the different between the sale price and the cost of the property.
However, when you use inflation index, the change the gains change: Indexed cost of property = Cost of the property X (cost inflation index of the year when property is sold/cost inflation index of year when property was bought). So, Capital gains after indexation = Sale price of the property – Indexed cost of the property.
Buy or Construct a residential property
There are instances when buying a house from the sale proceeds of an older house can save your tax outgo. Section 54 gives relief to a taxpayer who sells his residential house and from the sale proceeds acquires another residential house. You can also save capital gains tax if the sold property is not a residential property. Under section 54F, the capital gain is exempted if the sale proceeds of non residential property are invested in a residential property.
According to the rules of Section 54 and Section 54F, the capital gains from sale of a property can be set off against the purchase of new residential house. So, if you use the total capital gain for the purchase of new property, there would not be any capital gains tax. You can buy a new house one year before the sale of old house and benefit from this tax benefit. You can also buy a new house two years from the sale of old house or you can construct a house and within three years from the sale of the older house. Note; this exemption is available for one residential house.
The other clause that you need to be aware of is that you can’t sell the new house for the next three years from the date of purchase when Section 54 benefits have been availed. Under section 54, the amount of exemption would be lower of capital gains or cost of new house. Likewise, under section 54F, the amount of exemption would proportionate to the sale price and purchase price of the new house.
Capital Gains Bond Under Section 54EC
It is one of the most popular methods to save capital gains tax. This bond is a big relief to those people who already has a house and can’t take benefit of section 54. The investment into these bonds to save the capital gains tax. These bonds are open to investors and investments in these are exempt from capital gains tax. You can put all of your capital gains into these bonds. The money invested into these bonds is exempted from the capital gains tax, with a defined annual interest rate, which is normally around what a fixed deposit offers. However, the interest earn from capital gains bond is taxable but TDS is not applicable.
You need to invest the capital gains into these bonds within six months of capital gain realisation. And, the money needs to be invested for three years, as a lock-in. If you keep the money beyond, you do not earn any interest, and the redemption of capital gains bond has become automatic. The other restrictions are that you cannot transfer these bonds to anyone or pledge or sell them. You also have the option to invest an amount lesser than the capital gains, in which case only a proportionate capital gains is exempt from tax.
Capital Gains Account Scheme
There is another method to save capital gains tax. This scheme is for those people who can’t invest in a new residential property before e-filing income tax return. It gives relief to the taxpayer for time being. You can put money in this scheme for three year, during which time you can use the capital gains for purchasing or constructing a new residential house. The deposit in this account should be made before filing income tax return and the investment in capital gain account scheme should be mentioned in the income tax return. This account can be opened only with specified banks, but cooperative bank and regional bank are not eligible for this account.
The deposit can be made in lump sum or in instalments at any time on or before the due date for filing the return of income. You sold a property on 15 January 2015, and are not able to use the gains by 31 July 2015. In such a situation, you should open a CGAS account and deposit the money in it by 31 July. There are two types of accounts—account A and account B. Account A is similar to a savings account. You can put or withdraw money as per your requirements and the interest in this account is similar to the savings account. In case of Account B, which is like a fixed deposit; you put the money for the specified period and the interest rate is comparable to the fixed deposits.
Set off capital loss
This is yet another way to save tax on capital gains arising from the sale of the property. It gives you an opportunity to set off the capital gains against the capital loss incurred earlier. It is similar to same year adjustment of capital gains and capital loss. The capital loss should be from the earlier date and short term capital gains can be set off against the short term capital loss only. Likewise, long term capital gains can be set off against the long term capital loss, with the provision to carry forward capital loss for 8 subsequent years.
Make sure you mention the carry forward of capital loss in the income tax return. The long term capital loss of listed securities can’t be used against the long term capital gains. It means, you can’t carry forward the long term loss of share or equity mutual fund investment. As long term capital gains from shares, equity mutual fund and listed securities does not attract capital gains. To carry forward the capital loss, the income tax return should be filed before the last date of income tax return filing.