Most people invest in property to see greater returns in the future, but are not aware that ‘timing’ plays a major role in fetching the best returns. While one can sell the property immediately once they see an appreciable market value, they must consider the tax implications on the sale of property.
Types of Capital Gains on selling of property
As per the Income Tax rules the capital gain tax structure is divided into 2 categories- Short Term Capital Gains (STCG) and Long Term Capital Gains (LTCG).
Short Term Capital Gains (STCG)
If an investor buys and sells property within 36 months, his profit comes under STCG. This gain is included in his taxable income for that year and is taxed as per his tax slab.
Long Term Capital Gains (LTCG)
If an investor buys property and sells it after 36 months, his profit comes under LTCG. LTCG is taxed at a flat rate of 20%. If the person’s total income apart from the LTCG is less than the zero slab, then only the LTCG over the zero slab attracts tax at 20%.
How to calculate Capital Gains
The short term capital gain is calculated by deducting from the sale price the cost of acquisition, the money spent on improving the property and the transfer cost. For long term capital gain, tax calculation involves what is known as indexation. The acquisition cost or cost of acquiring the asset is recalculated based on indexation. Indexation is a concept, which factors inflation in its calculation by using a factor called cost inflation index (CII). The cost inflation index number is published every year by Reserve Bank of India (RBI).
STCG = Sale price – (Cost of acquisition + Cost of improvements + Cost of transfer)
LTCG = Sale Price – (Indexed cost of acquisition + Indexed cost of improvements + Cost of transfer)
|Sale price||Price the house is sold at|
|Cost of acquisition||Sum total of amount spent for acquiring the asset|
|Cost of improvements||All expenditure of a capital nature incurred in making additions or alterations to the capital asset|
|Cost of Transfer||Other costs incurred while selling the property. This may include brokerage paid for arranging the deal, legal expenses incurred for preparing conveyance and other documents, cost of inserting advertisements in newspapers for sale of the asset and commission paid to auctioneer, etc.|
|Indexed cost of acquisition||Cost of acquisition x (CII of year of transfer / CII of year of acquisition)|
|Indexed cost of improvements||Cost of acquisition x (CII of year of transfer / CII of year of improvements)|
How does one avail tax benefits on the re-investment of these gains?
A property owner cannot avoid tax on short term capital gains but can claim exemption from the long term capital gains on the reinvestment of the capital gains/sale proceeds only in particular investment avenues, subject to certain conditions.
Buying a property
A property seller can claim long term capital gain exemption by using the entire profit to either buy another property within a period of 2 years or can even construct a house in 3 years. However, he can only invest in a residential property and not a commercial property or a vacant land. He can also avail tax exemption if he has bought a second property one year before the transfer of the property.
Investing in the Capital Gains Account Scheme (CGAS)
In case the property owner fails to make an investment at the right time to avail the tax exemption benefits for capital gains, he/she can deposit the amount of capital gain/the net consideration in a separate account with a nationalized bank as per the Capital Gains Account Scheme (CGAS). However, the deposited money can be used only to buy or construct a residential house within the prescribed time frame. Failure to do so will lead to taxation of the unutilized amount as long-term capital gain after three years of the sale of the first property. One can either create a Type A (savings deposit account) or a Type B (term deposit account) as they both have the same interest rates as that of regular savings and term bank deposits.
Investing in Bonds
A person selling property falling under the LTCG can claim tax exemption under Section 54EC of the Income Tax Act by investing in notified bonds within six months of transfer of the property. These bonds are issued by the National Highway Authority of India and the Rural Electrification Corporation. However, if you transfer or take a loan against these bonds within three years, the capital gain will become taxable.