In India, you pay a capital gains tax on the sale of a capital asset and a property is a capital asset. So, if you have purchased a property for Rs 10 lakhs in 2008 and sold it in 2014 for Rs 30 lakhs, you need to pay capital gains tax on property on the profit of Rs 20 lakhs. Of course, you have to take indexation into consideration.
How this capital gains is calculated and what is the capital gains tax rate, we shall see later.
What is capital gains tax on property and types of capital gains?
If you sell the property at a profit in less than three years, then short term capital gains tax shall be applicable. On the other hand if you sell the property after three years, then a capital gains tax of 20 per cent shall apply after indexation.
The government gives you the benefit of indexation, because of inflation. There is an indexation calculator that you must use. For example, while the property purchased in 1980 may have gone up, so has inflation. Hence, you need indexation to arrive at the exact calculation for paying capital gains.
How to save on capital gains tax?
Now, as indicated you have to either pay short term or long term capital gains tax. However, you can avoid paying capital gains tax by doing one of the following:
a) Reinvesting sale proceeds in another property
You can reinvest the entire sales proceeds in another residential property. Please note, it is residential and not commercial property. This has to be done within a 2-year time frame. So make sure that after you sell, you begin your hunt for a new property immediately.
b) Construction of another property
The sale proceeds can also be used to construct another residential property and the leeway one gets is three years and not two years. This again has to be dome within the stipulated time frame, to give you the ability to save on capital gains tax.
c) Sale proceeds to be invested in capital gains bonds
You can also invest the amount in capital gains bonds. These are issued by two government owned entities including the National Highways Authority of India and the Rural Electrification Corporation. There is a cap of Rs 50 lakhs that has been fixed and one cannot invest more than this amount. The interest rate on these bonds is not very much and is around the six per cent mark.
The bonds have been highly rated and come with AAA/Stable by CRISIL and IND AAA(Stable) by India Ratings and Research. In any case the chances of a default on these bonds is minimal given the fact that they are government backed institutions.
These bonds are not paying any great interest rate. In fact, the interest rate is just 6 per cent, which makes them highly unattractive. Interest on the same can keep varying and you need to check the latest interest rate.
Best option to save on capital gains
We believe that investment in the capital gains bond to save taxes is not attractive. It is best to use the proceeds to buy or construct another house. The National Highways Authority of India capital gains bonds, gives you an interest rate of just 6 per cent every year.
The best thing to do would be first to calculate and see, how much capital gains you are likely to pay. Based on that you should take a decision. If the amount of capital gains payable to the authorities is rather high, you could well go for another house.
Pay your taxes legitimately
It is best to pay your capital gains tax, if you have exhausted all the means to save on them as mentioned above. There are individuals who get into complicated deals to avoid paying tax. This is not the best thing to do and it is best to stay in compliance with the laws and the present guidelines. Work along side a Chartered Accountant or a tax expert in case the deal is really large and the liability that is arising in case of sale of property is really big ticket one.
Interestingly, even equity shares would now attract a long term capital gains, bringing it on par with property and gold. This is a good move by the government of India to treat all investments on par in terms of capital gains. In any case one needs to be take all things into consideration after the sale of property.