Real estate is generally a great term investment option if you have patience and financial resources to acquire and sustain it. It helps in generating continuous passive income and is a good strategy to begin building wealth for future financial stability and security. There will be taxes and regular maintenance charges to cover so gaining technical and practical know-how about this investment option is a good place to start. Livemint.com also highlighted a study by the Institute for New Economic Thinking which states that “residential real estate, not equity, has been the best long-run investment over the course of modern history”. Their study finds that while returns on housing and equities have been similar in the long-run, housing has been much less volatile. Hence, risk-adjusted returns from housing has been better over the long run and that is why buyers prefer it while financial planning.
Not many are aware of the capital gains tax. It often comes up as an unexpected tax for many people. In some situations, it can turn out to be a huge tax and can eat up the profits you earn while selling a property. The capital gains tax you pay depends on whether it’s short term or long term. Short term capital gains are added to your taxable income, and you have to pay income tax according to the different tax slabs. Long term capital gains attract 20% tax on the gains.
On the other hand, capital loss is the loss incurred when any capital asset depreciates in value and the loss is realized when the asset is sold for a price lower than the original purchase price. In essence it’s the difference between the purchase price and the sale price where the latter is lower than the former. So if a house bought for $350,000 is sold 5 years later for $300,000, the capital loss comes out to be $50,000.
A property tax assessment is undertaken annually to determine the market value of the property. It is carried out by determining the area it is in, occupancy status (self-occupied or rented out), type of property (residential, commercial or land), amenities provided (parking, rainwater harvesting etc.), year of construction, type of construction (multi-storied/ single floor, pucca/kutcha structure, etc.), floor space index and carpeted square area of the property.
There are several smart ways that you can save on capital gains tax in India. Here, in today’s post, we show you all that you need to know about this tax and the best ways to reduce it.
What is Capital Gains Tax in Real Estate?
Simply put, capital gains is the profit you make when you sell a capital asset – a plot of land, a residential house, a commercial building or any other capital asset for a higher price than the price you paid for acquiring it. The rates levied are 20% for Long Term Capital Gains (LTCG) and Short Term Capital Gains (STCG) depending on an individual’s tax bracket. Capital gains can be divided into two major classifications:
|Long Term Capital Gains Tax Exemptions on Sale of Land/House|
|Section 54||Section 54EC||Section 54F|
|Who can claim the exemption?||Individual/HUF||Any person||Individual/HUF|
|Asset sold/transferred||Residential Property||Land Or Building or Both||Land/Plot (other than Residential House)|
|Holding period of Original Asset||More than 2 Years||More than 2 Years||More than 2 Years|
|New Asset to be acquired||Residential House||Notified bonds||Residential House|
|Time limit for new investment||Purchase: 1 year backward or 2 years forward||Within 6 months||Purchase: 1 year backward or 2 years forward|
|Construction: 3 years forward||Construction: 3 years forward|
|Exemption Amount||Investment in the new asset or capital gain, whichever is lower||(Long Term Capital Gain) Amount invested in new asset or bonds or capital gain, whichever is lower (maximum upto Rs.50 lacs)||(Long Term Capital Gain x Amount invested in new house) divided by sale proceeds of original asset i.e Net Consideration or Capital gain , whichever is lower|
How to Calculate Capital Gains Taxes?
For short term capital gains, here’s the formula to use:
|Calculation of Short Term Capital Gains|
|Total Sale Price (Full Value of Consideration)||xxxx|
|Less:||Expenses related to Sale/Transfer||xxxx|
|Less:||Cost of Improvement||xxxx|
|NET SHORT TERM CAPITAL GAINS||xxxx|
Short term capital gains = Total sale price of the property – (cost of initial purchase + expenses incurred during the sale + cost of renovations made (if any).
This amount should be added to your taxable income.
The formula for long term capital assets is similar; however, the one difference is that the “Indexed Cost of Improvement/Indexed Cost of Acquisition” from the sale price.
|Calculation of Long Term Capital Gains|
|Total Sale Price (Full Value of Consideration)||xxxx|
|Less:||Indexed Cost of Acquisition||xxxx|
|Less:||Indexed Cost of Improvement||xxxx|
|Gross Long Term Capital Gains||xxxx|
|Less:||Exemptions U/S 54 Series||xxxx|
|NET LONG TERM CAPITAL GAINS||xxxx|
To arrive at the indexation, you should apply the cost inflation index (CII). Indexation helps you adjust the purchase price to account for the rate of inflation for the years you have held the property. This accordingly increases your cost base and lowers capital gains on par with the inflation rates.
Who should pay Capital Gains Tax for Real Estate Selling?
If you sell a house, an apartment, a plot of land or any other property for a price higher than what you initially purchased it for, then you are liable to pay capital gains tax.
How to file Capital Gains Tax in India?
Once you have calculated your capital gains and the type, the next step is to include it in your income tax returns. You have to disclose details like cost of purchase, type of asset, sales consideration, transfer expenses, etc. in your income tax details.
Now, that you’ve understood the basics of what is capital gains tax and how to calculate and file it, let’s take a look at some ways to save capital gains taxes in India while selling a property.
Ways to Reduce Capital Gains Tax
Generally, the capital gains tax you have to pay when selling a property runs in lakhs. However, you can substantially reduce it by using one of the following methods:
1. Exemptions under Section 54F, when you buy or construct a Residential Property
Very often, when people move to a new house, they sell their old house to pay for the new house. In such cases, if you use the sale proceeds obtained from selling your old property to pay for the new one, you are exempted from capital gains tax under Section 54F, if you meet the following conditions:
Currently, Section 54F applies to only one residential property. It allows for the sale of non-residential property to purchase a residential property. If you use the entire capital gains for the purchase of the new property, then you don’t have to pay any capital gains tax.
Who is it for? Exemptions under Section 54F is ideal for people who sell a property to pay for the purchase of a new residential property.
2. Purchase Capital Gains Bonds under Section 54EC
If you are selling a property, but have no interest in purchasing a residential property using the proceeds, then you can make use of capital gains bonds.
Let’s take a look at the features of capital gains bonds:
Who is it for? Capital gains bonds work well for people who aren’t interested in purchasing a new residential property.
3. Investing in Capital Gains Accounts Scheme
Purchasing a new residential property may take time. You have to find a preferred home/apartment that you like to buy, negotiate with the seller and complete paperwork – all of which can be time-consuming.
Investing in capital gains accounts gives you temporary relief. Consider this as parking your capital gains tax safely for the time being, while you scout for a new property. You can invest the capital gains you obtained by selling a property in a public sector bank or other banks approved by the capital gains account scheme of 1988.
If you manage to find great companies and hold their stock for the long term, you will pay the lowest rate of capital gains tax. Of course, this is easier said than done. A company’s fortunes can change over the years, and there are many reasons you might want or need to sell earlier than you originally anticipated.
When you invest your money through a retirement plan, such as a 401(k), 403(b), or IRA, it will grow without being subject to immediate taxes. You can also buy and sell investments within your retirement account without triggering capital gains tax.
In the case of traditional retirement accounts, your gains will be taxed as ordinary income when you withdraw money, but by then you may be in a lower tax bracket than when you were working. With Roth IRA accounts, however, the money you withdraw will be tax-free, as long as you follow the relevant rules.
For investments outside of these accounts, it might behoove investors who are near retirement to wait until they actually stop working to sell. If their retirement income is low enough, their capital gains tax bill might be reduced or they may be able to avoid paying any capital gains tax. But if they’re already in one of the “no-pay” brackets, there’s a key factor to keep in mind: If the capital gain is large enough, it could increase their taxable income to a level where they’d incur a tax bill on their gains.
You can use capital losses to offset your capital gains as well as a portion of your regular income. Any amount that’s left over after that can be carried over to future years.
If you experience an investment loss, you can take advantage of it by decreasing the tax on your gains on other investments. Say you own two stocks, one of which is worth 10% more than you paid for it, while the other is worth 5% less. If you sold both stocks, the loss on the one would reduce the capital gains tax you’d owe on the other. Obviously, in an ideal situation, all of your investments would appreciate, but losses do happen, and this is one way to get some benefit from them.
If you have a capital loss that’s greater than your capital gain, you can use up to $3,000 of it to offset ordinary income for the year. After that, you can carry over the loss to future tax years until it is exhausted.
When you’ve acquired shares in the same company or mutual fund at different times and at different prices, you’ll need to determine your cost basis for the shares you sell. Although investors typically use the first in, first out (FIFO) method to calculate cost basis, there are four other methods available: last in, first out (LIFO), dollar value LIFO, average cost (only for mutual fund shares), and specific share identification.
In your income tax returns, you can claim tax exemptions for the money you have parked in capital gains accounts in approved banks. You don’t have to pay any tax for it. However, the amount has to remain with the bank for three years, failing the deposit will be treated as capital gains, and you have to pay tax for it in the next financial cycle.
Who is it for? Investing in capital gains account scheme is ideal for people who want to purchase a residential property by using the proceeds but want a place to park it temporarily, till they complete the details of the purchase.
Example of Capital Gains Tax while Selling Property in India
Say Mr Amit purchased a house in 2001-02 for INR 10,00,000. He happily lived in the house with his family and children. His children have grown up and are well-settled in the USA. Hence, In 2018, he plans to sell his current property for Rs. 40,00,000 and use its proceeds to buy a new home at a purchase price of Rs. 40,00,000.
The long term capital gain for Amit in this situation is calculated below.:
|Selling Year of the house||2018-2019|
|Original Cost of Acquisition||Rs. 10,00,000|
|CII of 2001-2002||100|
|CII of 2018-2019||280|
The capital gains tax he will save on the deal of selling his property in India is calculated as below:
|Sales Consideration||Rs. 40,00,000|
|Less-||Indexed Cost of Acquisition||Rs. 28,00,000|
|Long Term Capital Gain||Rs. 12,00,000|
|Less-||Exemption from Tax:|
|a) Section 54: Purchase of new house||Rs. 40,00,000|
|b) Section 54EC: Investment in REC/NHAI Bonds||————-|
|NET TAX PAYABLE||Rs. 0|
Hence, the purchase value of the new house is more than the long term capital gain, the tax payable will be nil in this case. Capital gains tax is one of the unavoidable side-effects of selling property in India. However, you can avoid paying large sums as capital gains tax by using any one of the above methods listed here. Understand the different exemptions available to you and pick the right one that suits your specific situation.
Ashiana, Ashiana Housing build homes. Homes surrounded by vast green spaces and fresh breeze. Homes cocooned in secured gated complexes. Homes where futures are forged and there are opportunities to grow. And Homes in environments brimming with healthy activity, trust and respect. At heart, we build communities with care.
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