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Long Term Capital Gains on Real Estate

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What does it mean - When you sell a property at a profit, any time three years after purchasing it, the difference between the sale price and the purchase price will be treated as long term capital gains. 

What is the sale value - The sale value will be the amount arrived at based on the valuation as per the state's Stamp Duty and Registration Authority and not the amount mentioned in the sale deed. This is simply to include cases where a part of the sale consideration is in the form of unaccounted cash.

How is Long Term Capital Gains taxed - This gain is taxed at the rate of 20% with indexation. By indexation, we mean that the cost inflation index is adjusted to reflect the increase in prices from the date of purchase till the date of sale. The Cost Inflation Index is issued by the Government and represents the increase in the general price level in the economy. Inflation reduces the value of the property over time and so using the cost inflation index inflates the property value to represent the current value. The capital gains is thus reduced as the purchase price is increased, thus reducing the tax burden of the seller. Note that this benefit of indexation is not available for short term capital gains.

Indexed Purchase Price = 15,00,000*590/280 = Rs. 31,60,714
Long Term Capital Gains = 35,00,000 - 31,60,714 = Rs. 3,39,286
Tax with indexation = 3,39,286*20% = Rs. 67,857

Any cost incurred after April 1st 1981, on improvement of the property can also be deducted (post indexation). This will bring down tax liability further.

How can you reduce/avoid the tax burden - Under Sec 54 of the Income Tax Act, you can claim a tax exemption on the long term capital gains of sale of a house. The gains are exempt from tax if you use the entire profit amount to purchase a new house within two years from the date of sale or construct a house within 3 years. Tax is also exempt if you have purchased a second house within a year before selling the first house. Note that you cannot invest in a commercial property or land for this purpose and the new investment has to necessarily be in a residential property.

Another option to avail tax exemption is under Sec 54(EC), by investing the amount of capital gains in bonds of the National Highways Authority of India or Rural Electrification Corporation Limited for a period of three years. However, this must be invested within a period of six months of selling the house. Further, the maximum amount that can be invested in a year under this option is Rs. 50 lakhs.

What happens if you sell the new house - When you dispose the new house purchased/constructed, the capital gains which have been exempted will be reversed and will again be taxed as capital gains. However, it will be charged as short term capital gains, which is charged at the normal tax slab rates and not the preferential 20% (with indexation) rate.

What happens if you do not invest in a house within the specified time period- If you are unable to invest in another property to claim exemption on long term capital gains, there is another option. You can invest in a separate account in a nationalised bank under the Capital Gains Account Scheme (CGAS) before the last date of filing your return for the particular year. The amount to be invested should be equal to the capital gain if you want to claim exemption on the entire amount.  You must attach the proof of deposit in the account, along with your tax returns to claim exemption. The account can be one of the following two types - either a Savings Bank account or a Term Deposit account. The account carries the relevant interest rate - either the Savings interest rate or the Term Deposit interest rate, as the case may be. The amount deposited should be used only to buy or construct a residential house and failure to do so will result in taxation of the unutilised amount.

We recommend you to consult a chartered accountant to understand the actual implications of long term capital gains on the sale of property.    

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