Selling a house is a very big and exhausting undertaking in and of itself, so it can be very distressing to think that you will have to pay taxes on your capital gains. Land purchases are considered capital assets, and the profits you make from selling them are referred to as capital gains.
Therefore, if you want to sell your property, you will have to pay capital gain tax on the profits you make after deducting inflation and the indexed cost of acquisition, which varies based on how long you keep a capital asset. On the other hand, there are several ways to reduce the capital gain tax when selling a home.
The profit or the gains that you make by selling a capital asset is known as a capital gain. The gain made from the capital asset can be classified under two types: short-term capital gains and long-term capital gains, depending on the duration of the asset remaining in your ownership.
The tax that is charged on this capital gain is known as the capital gain tax. This tax is charged under the head of capital gains for the sale made in the previous year.
You are liable to pay the capital gain tax when:
- You have sold an asset that comes under the category of a capital asset.
- You have profited from the sale.
- The sale is made in the previous year (the year immediately before the assessment year)
A capital asset is any tangible or intangible property that is purchased as an investment for the long term. Capital Assets serve as the basis for the calculation of capital gains. According to the Income Tax Act, you can include the following under capital assets.
What is Included?
- Property: This is a wide head and includes both tangible as well as intangible properties. Tangible properties can be
- Lease rights
- Securities: The securities that are held by FII’s under the rules of SEBI can also be called capital assets
Which Assets are not Included?
The following, though called assets are not included under capital assets.
- Any raw materials that are used in business, as well as the stock in trade of any business or profession
- Items for daily personal use such as clothes, footwear, utensils, etc.
- Household items such as movable furniture, personal vehicle, etc. This excludes paintings and jewelry
- Agriculture land that is situated in the rural part of India is also not considered
- Gold bonds issued by the government. The gold deposit bonds issued under the gold deposit scheme are also not classified as capital assets.
How to Save Tax When You Sell a House
Any property sold after at least two years is considered long-term capital gains, and you must pay tax on it when you sell it. This tax is known as capital gains. The tax rate on long-term capital gains is a flat 20%.
The capital gain tax is to be paid on the profit earned after considering the inflation and indexed cost of acquisition. Indexation is basically a technique to adjust the cost of the asset according to the inflation index. It will increase your cost and reduce your gains and thereby, tax liability. “So under long-term capital asset, the benefit of indexation is available plus the person who falls in the tax bracket of 30% also gets the advantage of paying the lower tax rate of 20%,” according to ClearTax.
Ankit Jain, Partner, Ved Jain & Associates. explains the several ways to save on the capital gain tax on the sale of property.
1. Avail Indexation Benefit: One effective method to reduce the tax on the sale of a residential property is to take advantage of the indexation benefit. Indexation adjusts the purchase cost of the property to account for inflation. This effectively lowers the amount of capital gains and subsequently the tax on it. For property owners to leverage this benefit, they should hold the property for at least two years, as this benefit is only available for long-term capital gains.
2. Joint Ownership: If you have co-owned the property, capital gains from the sale can be divided amongst the co-owners, depending on their ownership share. By doing this, each co-owner can make the most of the basic exemption limit available to them, thereby possibly reducing the overall tax liability.
3. Reduce Selling Expenses: Remember that when you’re calculating capital gains, you can deduct certain selling expenses from the sale price. Key expenses like brokerage fees associated with the sale can be deducted, thereby lowering the capital gains and in turn, the tax payable.
Read Also: What is The Best Tax Deferred Investment?
To reduce the capital gains tax on selling a house, you can also live in the house for more than two years and keep receipts of all the expenses made on enhancing or renovating it. These expenses can be added to the cost of the house and help lower the taxable capital gain amount.
4. Buy New Property (Exemption under Sec 54): One of the most popular methods of saving tax on the sale of residential property is to reinvest the capital gains in another residential property.
- Purchase a new property either one year before or two years after the sale.
- Alternatively, construct a new property within three years post-sale. If you book a flat with a builder, please make sure that the flat’s completion date is well within the three-year period.
Long-term capital gains are exempted from taxation (under Section 54 of the Income Tax Act, 1961) for individuals and Hindu Undivided Families on the sale of a house property if:
- The capital gains are used to purchase or construct another house.
- The new house is purchased one year before or two years after the sale of the old house.
- The new house was constructed within three years after the sale of the old house.
- Only one additional house property is purchased/constructed.
- The property being bought/developed is within India’s national borders.
- You don’t sell the new house for three years after taking possession of it.
- If the cost of the new property is lesser than the sale amount, the exemption then only applies proportionately. The remaining money can be re-invested under Section 54EC in under six months.
“For example, in the case of Section 54, if a person made a long-term gain of Rs 5 crore from selling a house and spent Rs 3 crores on a new house, with an additional Rs 2 crores in the Capital Gain Account Scheme, the total exemption would be Rs 5 crore,” said Pallav Pradyumn Narang, Partner, CNK.
5. Buy New Residential Property (Exemption under Sec 54F): In cases where you sell an asset other than a residential property but use the proceeds to acquire a new residential property, you can claim an exemption.
– The new house must be purchased either one year before the sale or two years after the sale, or it should be constructed within a span of three years post-sale.
– For full exemption, the entire sale proceeds must be reinvested. If only the capital gain is used, then the exemption is granted proportionally.
– While claiming this exemption, the seller should not have more than one residential property, excluding the newly bought one.
6. Investment in Bonds (Exemption under 54EC): If you’re not keen on reinvesting the capital gains in property, consider putting them into bonds. By investing your capital gains in bonds specified by the government, you can achieve an exemption from tax. Make sure to invest within six months of the property sale to claim this benefit. These bonds have a lock-in period of 5 years.
Suppose, Mr. A is incurring long term capital gains of Rs.30 lakhs on the sale of his flat. He is considering investing the gains in bonds issued by NHAI. So, the capital gains can be invested in the bonds issued by NHAI and can be claimed as an exemption and the whole of capital gains shall be exempted of Rs 30 lakh.
7. Tax Loss Harvesting : An astute financial strategy often used by investors involves selling securities that have experienced a loss. By realizing, or “harvesting” a loss, investors can offset taxes on both gains and income. Losses from sales of mutual funds or shares can be used to offset capital gains on property sales. Moreover, this approach can be useful in rebalancing one’s portfolio.
8. Invest the capital gain in Capital Gain Account Scheme (CGAS) – If you are not able to purchase a suitable house or construct or are not able to find a suitable bond, then you can invest in CGAS of public banks for that assessment year. While filing income tax returns, you can claim exemptions for money in CGAS. However, the deposited amount in CGAS should be utilized within 3 years, or else you will be taxed for that amount.
9. Reinvest gains into shares of company engaged in manufacturing There is also a relatively less known provision, Section54GB, wherein any individual can reinvest long-term capital gains from the sale of a residential property into the shares of an eligible company that is engaged in the manufacturing activities, according to Narang. The limit for such reinvestment is Rs 50 lakh with the investor having to acquire more than 25% of the voting rights or 25% of post money share capital in the Indian MSME Company.
3 Ways to Save on Capital Gain Tax on the Sale of Property
Capital gains taxes are levied on the money received from the sale of capital assets. They are determined by the asset’s duration of possession and the real difference between the asset’s purchase and selling prices. This tax assessment only applies if the asset is sold after a predetermined period of ownership.
1. Invest in CGAS (Capital Gains Account Scheme)
Investing in Capital Gains Account Scheme (CGAS) is another means to save capital gains tax on property sales. This scheme is perfect for individuals who cannot invest in a brand-new property before their income tax return filing, and this scheme provides a huge relief to the taxpayers.
You can invest in this CGAS scheme for three years, and throughout this duration, you can utilize the capital gains for buying or building a residential house on your property. The deposit in this CGAS account must be made before filling or registering an income tax return, and then this investment in the Capital Gain Account Scheme (CGAS) must be specified in the income tax return.
This CGAS account can be opened only with designated banks. Also, regional banks and cooperative banks are not qualified to open this account. The deposit in this account can either be made through monthly installments or a lump sum to save taxes on capital gains.
2. Set off all Capital Losses
This is again the most suitable way to save tax on capital gains resulting from the sale of your property. It enables you to set off all capital gains or profits against the capital losses you incurred earlier. It is analogous to the same-year adjustment of capital loss and capital gains. However, the capital loss must be from the former date, and a short-term capital loss can only be set off against short-term capital gains.
3. Invest in Bonds
If you have recently traded your property and want to save on tax, you can further invest in specified financial assets. Investment in such financial assets holds the power to save your arduously earned capital gains as these long term capital gains are exempt under Section 54EC of the Indian Income Tax Act, 1961.
To obtain this tax exemption on your capital gains, you should invest the sum earned in bonds within 6 months of the transfer of the sum and realization of gains. In addition to this, the funds are required to be invested in these bonds for a minimum of three years as a lock-in period.
If you keep the funds invested in these bonds for a period beyond the lock-in period of three years, you will not gain any interest, and the redemption of these capital gain bonds will become automated. Other restrictions on investing your capital gains from property sales include the inability to assign, contract, or trade these bonds.
Section 1031 is a way for individuals to reduce their tax burden, and there are other options that homeowners can consider. As always, discuss your plans with a tax professional if you have a rental property you are planning to sell to learn which rules apply to your situation.