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The profits arising from the sale of a residential house property, which has a holding period of more than 24 months, are termed as long-term capital gains and are taxed at the rate of 20.80%. One can save on the long-term capital gains tax in several ways.
Investment in a residential house
If you have realised any long-term capital gains on the sale of a residential house, the first option to save the tax, is to avail of the exemption under Section 54 of the Income Tax Act. Section 54 requires you to invest your long-term capital gains in the purchase of any other residential house property in India. The investment can either be done in a ready house or for the construction of a house. Even booking of an under-construction house is treated as construction of house by you. If you invest the money in a ready residential house, the investment has to be made within two years from the sale of the residential house. Even if you had bought a new house within one year prior to the sale of the old house, you can still claim the long-term capital gains tax exemption.
If you wish to claim the exemption, by booking an under-construction house or constructing a house yourself, the construction of the house should be completed within a period of three years from the date of sale of the house. Even if you have started construction of the house before the sale of the residential house, or booked another residential house before the sale of the residential house, you can still claim this exemption, as long as the construction is completed within three years and the investment is made after the date of sale.
This long-term capital gains exemption under Section 54 can only be claimed, if the investment is made in India and that too in one residential house only.
There is one exception to the requirement to invest in one house only. The budget of 2019 has proposed a one-time exception, where exemption from long-term capital gains tax can be claimed under Section 54, by investing in two houses, where the aggregate of taxable long-term capital gains does not exceed Rs 2 crores on the sale of one house. This exception can be availed of by a tax payer, only once in his lifetime.
If the amount of capital gains in not fully utilised for the purchase or construction of the house, the unutilised capital gain amount is required to be deposited in a capital gains account, to be opened with a bank. The money deposited in a capital gains account can be withdrawn and utilised, for the purpose of purchase or construction of a house, within the time period specified above. In case the deposited amount is not utilised within three years, it becomes taxable as long-term capital gains, in the year in which the period of three years is over.
The residential house property that is purchased or constructed, in order to claim the exemption under Section 54, should not be sold or transferred for a period of three years from the date of its acquisition, failing which, the capital gains exemption claimed earlier gets forfeited and becomes taxable in the year in which the second property is transferred. If the new property is sold before two years, the amount of exemption claimed, along with any appreciation, shall become taxable as short-term capital gains. If the new house is sold after two years but before the completion of three years, the same shall be taxed as long-term capital gains in the year in which the new house is sold.
It may be noted that the exemption under Section 54, can only be claimed for investing taxable long-term capital gains from the sale of one residential house to another residential house in India. You can also claim the deduction with respect to long-term capital gains on the sale of more than one house, by investing the taxable long-term capital gains of such houses in one single residential house but the reverse is not true. So, you cannot claim exemption under Section 54, by investing the long-term capital gains in more than one house. In such a situation, you exemption will be restricted to investments made on one house. The exemption under Section 54 can also be used, if the investment is made in an entire building which is used by the family as a single residential unit. Even if investments are made in a duplex or adjoining flats, the benefit of exemption under Section 54 can be claimed in such situations.
Investments in capital gains bonds
The second option for saving tax on long-term capital gains arising from the sale of a residential property, is to invest the same in designated capital gains bonds of specified institutions. Presently, Rural Electrification Corporation (REC), National Highways Authority of India (NHAI), Railway Finance Corporation (RFC) and Power Finance Corporation Limited (PFC) are authorised to issue such bonds. The investments in these bonds have to be made within six months from the date of sale of the residential house property. Even if the period of six months falls beyond the due date of filing of the income tax return, you are not required to make any deposit in any capital gains account, as required under Section 54. Presently, these bonds carry an interest rate of 5.25% annually and the tenure of these bonds is five years. The interest on such bonds is fully taxable but the redemption proceeds of these bonds are tax-free.
Who can avail of the exemption from long-term capital gains tax?
The benefit of tax exemption through investment in residential house property, is available to individual and HUF assesses only. However, the option of claiming tax exemption through investment in bonds, is available to all assessees. You can use either one option or a combination of both the options, to claim exemption from income tax on the sale of a residential house property, as there is no restriction on claiming one option, if you have already claimed another with respect to the sale of one house property.
(The author is a tax and investment expert, with 35 years’ experience)