In today’s dynamic real estate market, purchasing property is not solely about owning a home anymore. Many individuals buy property with investment intentions, anticipating capital appreciation or rental income. Some buyers also see it as a stepping stone toward upgrading to a better residence in the future. When the time comes to sell such property, though, they face the responsibility of capital gains tax, which can significantly impact their profits. With the right knowledge and strategies, property owners can minimise their tax liabilities, save substantial sums, and make the most of their real estate transactions. This article provides a thorough guide to understanding capital gains tax on property sales and the exemptions available to reduce tax burdens effectively.
What is capital gains tax?
Capital gains tax (CGT) is a tax levied on profit from selling a capital asset, such as real estate, stocks, or bonds. In real estate, CGT is applied to the gain when a property is sold for more than the original price. This gain, or “capital gain,” is subject to taxation based on how long the property was held before selling. There are two main categories: Short-term capital gains tax (STCG) and Long-term capital gains tax (LTCG). The duration of keeping the property, alongside various exemptions and deductions, determines how the tax is applied.
What is capital loss?
A capital loss occurs when an asset, including property, is sold for less than the purchase price. Capital losses can be offset against capital gains to reduce overall tax liabilities. In real estate, a loss on the sale of a property can only be used to offset gains from other assets of the same category—short-term losses against short-term gains and long-term losses against long-term gains. While this might seem unfavourable, carrying forward these losses over the next eight financial years can provide tax relief when capital gains arise.
Who pays capital gains tax?
Individual property sellers who profit from selling their property typically pay capital gains tax. However, this tax doesn’t apply to property developers, brokers, or businesses in the real estate sector as a part of their regular income. For such entities, the profit is taxed as “income from business” or “other sources.” Ordinary property owners, though, who buy and sell homes or investment properties, are liable to pay capital gains tax on any profit realised.
What Are Capital Assets?
A capital asset is any tangible or intangible property purchased as a long-term investment, serving as the basis for calculating capital gains. According to the Income Tax Act, the following are included as capital assets:
Included Assets:
- Property: This encompasses both tangible and intangible properties.
- Tangible:
- Land
- Buildings
- Machinery
- Intangible:
- Patents
- Trademarks
- Lease rights
- Tangible:
- Securities: Securities held by Foreign Institutional Investors (FIIs) under SEBI rules are also considered capital assets.
Excluded Assets:
Certain items, despite being classified as assets, are not considered capital assets:
- Raw materials used in business or stock-in-trade.
- Personal items like clothing, footwear, and household goods (excluding paintings and jewelry).
- Agricultural land located in rural India.
- Government-issued gold bonds and gold deposit bonds.
Types of Capital Assets
Capital assets can be classified based on the duration of ownership:
- Short-Term Capital Assets: Held for less than 36 months. For specific assets, this period can be shorter:
- 24 months: Immovable properties (land, buildings) and unlisted shares.
- 12 months: Listed equity shares, preference shares, Unit Trust of India units, equity mutual fund units, debentures, government securities, and zero-coupon bonds (transfer must be post-July 2014).
- Long-Term Capital Assets: Held for more than 36 months. Movable assets like jewelry qualify as long-term if held for over 36 months, with the holding period varying by asset type (can be 12 or 24 months).
What is short-term capital gains tax?
Short-term capital gains tax (STCG) is applied when a property is sold within two years of acquisition. In such cases, the gain is added to the seller’s income and taxed according to the applicable income tax slab rate for the individual. STCG is calculated by subtracting the sale-related expenses (such as brokerage fees and transfer charges) and the purchase cost (including stamp duty and legal fees) from the property’s sale price. Since STCG is taxed at the individual’s marginal rate, those in higher income brackets may face a steep tax liability on short-term gains.
What is long-term capital gains tax?
Long-term capital gains tax (LTCG) is levied on properties sold after holding them for over two years. LTCG is calculated by considering the indexed cost of acquisition, which adjusts the original purchase price for inflation using the Cost Inflation Index (CII). For LTCG, the tax rate is typically 20%, plus applicable surcharges and cess, which is generally lower than the STCG rate due to indexation benefits. This indexation adjustment can reduce the taxable gain in cases of substantial appreciation, making LTCG more favourable for property owners.
How is the period calculated for capital gains?
For taxation purposes, the date of purchase is considered when the buyer receives the allotment letter or ownership transfer documents, not necessarily the payment date. This distinction is essential, as it determines the classification between short-term and long-term capital gains. For example, if a property were purchased on January 1, 2021, and sold on January 1, 2023, it would be considered a short-term capital asset. Conversely, if sold on January 2, 2023, it becomes a long-term asset. Therefore, understanding these holding period distinctions is crucial for tax planning and determining applicable tax rates.
How are capital gains calculated?
Short-term capital gains calculation
Short-term capital gains are calculated as follows:
Short-term capital gains=Total Sale Price−Expenses related to sale/transfer−Cost of purchase\text{Short-term capital gains} = \text{Total Sale Price} – \text{Expenses related to sale/transfer} – \text{Cost of purchase}Short-term capital gains=Total Sale Price−Expenses related to sale/transfer−Cost of purchase
Expenses related to sales include broker commissions, transfer charges, and legal fees. The purchase cost includes amounts paid to the developer, bank charges, GST, stamp duty, and registration fees. Renovation or improvement costs can also be deducted, reducing the net taxable gain.
Long-term capital gains calculation with indexation:
Long-term capital gains are calculated similarly, but the indexed cost of purchase adjusts the original purchase price for inflation:
Indexed Cost=Cost of acquisition×CII of sale yearCII of purchase year\text{Indexed Cost} = \text{Cost of acquisition} \times \frac{\text{CII of sale year}}{\text{CII of purchase year}}Indexed Cost=Cost of acquisition×CII of purchase yearCII of sale year​
For instance, if a property were purchased in 2003 for ₹10 lakhs and sold in 2023 for ₹1 crore, using the appropriate CII values (348 for 2023 and 109 for 2003), the adjusted cost would be:
10 Lakhs×348109=₹31.92 Lakhs10 \text{ Lakhs} \times \frac{348}{109} = ₹31.92 \text{ Lakhs}10 Lakhs×109348​=₹31.92 Lakhs
Thus, the taxable gain would be:
1 Crore−₹31.92 Lakhs=₹68.08 Lakhs1 \text{ Crore} – ₹31.92 \text{ Lakhs} = ₹68.08 \text{ Lakhs}1 Crore−₹31.92 Lakhs=₹68.08 Lakhs
Exemptions for saving on capital gains tax
Saving STCG
Unfortunately, STCG is treated as regular income and thus does not have specific exemptions. However, one can reduce STCG liability by deducting all eligible costs and expenses from the sale value.
Saving LTCG
Several sections of the Income Tax Act allow for exemptions on LTCG, enabling taxpayers to reduce or eliminate their capital gains tax liability on the sale of property.
Exemption under Section 54
Section 54 offers an exemption on the sale of residential property if the taxpayer reinvests the capital gains in another residential property:
- The number of properties: A one-time option to invest in up to two residential properties if the capital gains do not exceed ₹2 crores.
- Reinvestment amount: The entire capital gains amount needs to be invested in the new property to claim complete exemption.
- Timeline: The new property must be purchased within one year before or two years after the sale or constructed within three years of the sale.
- Holding period: The newly acquired property must be held for at least three years, or the exemption claimed becomes taxable as LTCG.
Exemption under Section 54F
This exemption applies to capital gains from the sale of any property other than residential property. Under Section 54F, taxpayers can claim an exemption by reinvesting the sale proceeds in a residential property:
- Reinvestment requirement: The total sale value, not just the capital gains, must be reinvested in a residential property.
- Timeline: Similar to Section 54, the reinvestment must occur within one year before or two years after the sale, or the new property must be constructed within three years.
- Conditions: The taxpayer must not own more than one residential property before this reinvestment to claim the exemption.
Exemption under Section 54EC
Section 54EC allows taxpayers to invest capital gains from property sales in specified government bonds (e.g., NHAI or REC bonds).
- Investment limit: Up to ₹50 lakhs in these bonds per financial year.
- Lock-in period: The bonds must be held for at least five years.
- Timeline: Investment must be made within six months of the sale or before filing the tax return for that financial year.
Capital Gains Account Scheme (CGAS)
For taxpayers who wish to defer their reinvestment, the Capital Gains Account Scheme (CGAS) allows them to park their funds in a particular account until the reinvestment is made. This scheme enables reinvesting within the stipulated time without immediately owing capital gains tax.
What if there is a capital loss on the sale of property?
If a capital loss arises, it can be adjusted against capital gains, reducing overall tax liability. Short-term capital losses can offset short-term gains, and long-term losses can be offset against long-term gains. Moreover, long-term capital losses can be carried forward for up to eight years to adjust against future gains, potentially offering significant tax relief.
How to avoid capital gains tax on inherited property in India
When inheriting property in India, the inheritor does not incur capital gains tax at the time of inheritance. However, if the property is later sold, capital gains tax is applicable on the sale proceeds. Fortunately, the same exemptions and indexation benefits that apply to regular property sales also apply to inherited property. Here’s a step-by-step guide for calculating capital gains on inherited property and minimising the tax burden:
Step-by-step process
Step 1: Determine the Cost of Acquisition and Indexation
To calculate capital gains, the inheritor needs to know the original cost of acquisition (i.e., the purchase price) and the cost indexation from the previous owner’s purchase date. The acquisition cost will be the original price the previous owner paid for the property.
Step 2: Identify the Original Cost of the Property
The acquisition cost is based on what the previous owner paid for capital gains calculations. The inheritor did not incur a fee when the property was passed down to them, so the original cost remains relevant.
Step 3: Apply Indexation Based on the Previous Owner’s Acquisition Year
The cost indexation is based on the year the previous owner bought the property. This means the Cost Inflation Index (CII) applicable during that year and the year of sale are used to adjust the purchase price for inflation.
Step 4: Use the Base Year for Calculations
For properties acquired before April 1, 2001, the base year for calculating indexation has been updated to 2001. For example, if the property was acquired before this date, the value in 2001 is taken as the acquisition cost for indexation purposes.
Step 5: Calculate the Indexed Cost of the Acquisition
Use the formula: Indexed Cost = Cost of Acquisition × (CII of Year of Sale / CII of Year of Purchase). This indexed cost represents the inflation-adjusted purchase price.
Step 6: Subtract Indexed Cost from Sale Price
Subtract the indexed cost from the actual selling price to arrive at the net capital gain, subject to capital gains tax. Any exemptions available under Section 54 or 54F for reinvestment can be applied here to reduce tax liability further.
Example Calculation
Consider this scenario:
Mr. X purchased a property on August 1, 2004, for ₹75 lakhs.
Y inherited this property from Mr X in 2012 and decided to sell it in May 2014 for ₹1.8 crores.
Here’s how the calculation works:
- The original cost of the property is ₹75 lakhs, which Y inherits.
- For indexation, the CII of 2004-05 (the year of purchase) is 113, and the CII for 2014-15 (the year of sale) is 240.
- Using the indexation formula: Indexed Cost=₹75 lakhs×240113=₹1.6 crores\text{Indexed Cost} = ₹75 \text{ lakhs} \times \frac{240}{113} = ₹1.6 \text{ crores}Indexed Cost=₹75 lakhs×113240​=₹1.6 crores
- The net capital gain is then calculated as: Net Gain=Sale Price−Indexed Cost=₹1.8 crores−₹1.6 crores=₹20 lakhs\text{Net Gain} = \text{Sale Price} – \text{Indexed Cost} = ₹1.8 \text{ crores} – ₹1.6 \text{ crores} = ₹20 \text{ lakhs}Net Gain=Sale Price−Indexed Cost=₹1.8 crores−₹1.6 crores=₹20 lakhs
This net gain of ₹20 lakhs will be subject to long-term capital gains tax. Notably, the date or year of inheritance does not impact this calculation, as the indexation is always based on the original purchase date.
Housing.com POV
Understanding how to manage and reduce capital gains tax on property sales, whether inherited or otherwise, can lead to significant financial benefits. By exploring exemptions under Sections 54, 54F, and 54EC, taxpayers can strategically reinvest their gains and minimise their tax liabilities. Planning the sale and reinvestment process wisely, keeping track of applicable timelines, and being aware of the relevant tax provisions are all essential steps. With this knowledge, individuals can maximise their property investments and optimise their tax outcomes.
FAQs
Will the benefit of Section 54/54F be available if the residential property is purchased in the name of the taxpayer's wife?
Yes, the benefit under Section 54/54F is available even if the residential property is purchased in the name of the taxpayer's spouse. The taxpayer can still claim the exemption on capital gains if all other conditions are satisfied.
Will the benefit of Section 54/54F be available on the sale of assets made outside India?
Yes, assets can be sold outside India; however, for the exemption under Section 54/54F, the new residential property must be purchased in India. Overseas properties do not qualify for the exemption.
Will the benefit of Section 54EC be available in addition to the benefits under Section 54/54F?
Yes, taxpayers can benefit from Section 54 or 54F and Section 54EC. Section 54/54F covers the purchase or construction of residential property, while Section 54EC allows reinvestment of capital gains into specified bonds, providing a dual exemption if all conditions are met.
How can I avoid tax on long-term capital gains?
You can avoid long-term capital gains tax by claiming exemptions under Sections 54, 54EC, and 54F, provided you meet the conditions associated with each section. These may include reinvestment into another property or specified bonds within the prescribed time frames.
What is the exemption for long-term capital gains on the sale of property?
The exemptions on long-term capital gains from the sale of property include: Section 54: Reinvestment of gains from selling a residential property into another residential property. Section 54F: Reinvestment of gains from the sale of any long-term asset (except residential property) into a residential property. Section 54EC: Investment of capital gains in specified bonds issued by the National Highway Authority of India (NHAI) or Rural Electrification Corporation (REC).
Is it mandatory to show capital gains in the ITR?
Yes, it is mandatory to report capital gains in the Income Tax Return (ITR), whether short-term or long-term. Failing to report capital gains can lead to penalties or scrutiny from the Income Tax Department.
Do senior citizens have to pay capital gains tax in India?
Yes, senior citizens must pay capital gains tax, as there are no specific exemptions from capital gains tax based solely on age. However, other taxpayers can benefit from the same exemptions under Sections 54, 54EC, and 54F.
Can I claim exemptions under both Section 54 and Section 54F simultaneously?
Yes, exemptions under Sections 54 and 54F can be claimed in the same year if all relevant conditions are met. However, if you purchase a residential property within one year of selling another, you may not be eligible to claim the Section 54F exemption on that new property.
Can I claim exemptions under both Section 54 and Section 54EC simultaneously?
Yes, you can claim both Section 54 for the reinvestment of capital gains into a residential property and Section 54EC for reinvestment into specified bonds. This allows dual tax-saving benefits if each section’s conditions are met.
