In India, whenever you sell a residential property and earn capital gains on it, you have to pay tax on the profit. Let’s see how this works:
For instance, if you purchased a property in 2013 for Rs 20 lakhs but sold it in 2017 for Rs 40 lakhs. You have to pay capital gains tax on the Rs 20 lakhs profit earned.
What Is Capital Gains Tax On Residential Property?
Capital gains tax on residential property is a tax amount you have to pay when you sell a property like an apartment owned by you. This taxed is calculated on the amount of profit acquired by selling a property.
The profit is the amount difference between the initial purchased value minus the value at which property is sold.
There are two types of capital gains tax:
• Long term capital gains tax: You are liable to pay long term capital gains if you sell the purchased residential property after 3 years and 20% capital gains tax is applied after indexation.
• Short term capital gains tax: You are liable to pay short term capital gains if you sell the purchased residential property within 3 years of the original purchase date.
The government still provides you the advantage of indexation because if the property rates have increased, inflation has also increased. So, indexation is used to exactly calculate capital gains tax.
How Can You Save Capital Gains Tax On Residential Property?
As already discussed, you are liable to pay either long term capital gains tax or short term capital gains tax. Here are some ways to save tax on residential property.
1) Reinvest in another residential property
When you sell a residential property, you can save capital gains tax by reinvesting the whole profit amount in another residential property. For this, if you have purchased a property in the time frame of previous 1 year, which is calculated from the transfer date of the property being sold, then you can get exemption under section 54.
Additionally, under this section, if you have not already purchased a residential property in the previous year, you can reinvest the profit amount in next 2 year in any residential property of India. This 2-year period is calculated from the date of transfer of the property being sold.
2) Construction of another residential property
Under the same section 54, if you initiate the construction of property within next 3 years, you can get tax exemption. This 3-year period is calculated from the date of transfer of the property being sold. Also, both the clauses, construction and reinvestment, of section 54 is applicable to only single Indian residential property.
3) Invest in NHAI or REC bonds
There are various bond schemes issued by Rural Electrification Corporation (REC) and National Highway Authority of India (NHAI) which can help you in tax exemption. When you are not willing to invest in another property or you have exhausted that option, REC and NHAI bonds are a great option.
However, you can only invest in first 6 months calculated from the date of transfer of the property, and the invested amount can reach to Rs 50,00,000.
Additionally, from the date of transfer of the property till 3-year completion, you can’t sell these bonds.
4) Invest in capital gains account
You may come across a situation where you can’t purchase or construct a new residential property before the last date of return filing. In such a scenario, you can deposit the amount to be invested in capital gains account. Usually, most public banks provide the facility of capital gains account.
However, you should note that this amount would be tax exempt only if it is utilized for property construction or purchase within 3 years. After the completion of 3 years calculated from the date of the property transfer, this amount will be liable to tax from that year.
Best Way to Reduce Capital Gains Tax on Residential Property
The first move before taking any measure is to calculate the capital gains tax you are liable to pay. If the tax amount is too much, then look for options to save it.
Investing the acquired money in capital gains bond is not an appealing option because these bonds offer low interest rates, generally, 6 per cent per year. Hence, if you still have an option of buying a new property or constructing one, we suggest you to take that option.
What Can Do in Case of Loss in a Residential Property?
Many a times property rates go down and you have to suffer a loss. In such a situation, your long term capital loss after the property is sold can be cancelled with the long term capital gain that you acquired when you sold any capital asset excluding shares, mutual bonds, etc.
When you can’t set off full long term capital loss in one financial year, then you can set off the remaining portion for next 8 years. But, only the same head can set off this amount.
When Every Option Is Ruled Out
If you deal in property a lot, then you may come across a situation where you have exhausted all these options. We suggest you to pay the capital gains tax according to laws and guidelines of India. Involving in complicated procedures for saving some tax is not a good option, and staying compliant with the law is always preferable.
If you are still worried about the capital gains tax, then talk to your CA (Chartered Accountant) or any tax expert for exact tax exemption method in case of high capital gains tax.
It is important to evaluate your options beforehand. Carefully, calculate the amount of capital gains tax that you have to pay and then select the most feasible option. If you have already bought a property in past one year, that is the most practical approach for saving your capital gains tax. Otherwise, always keep property construction or purchase as your first option.
It is important that you make the best use of the exemptions provided, so that you reduce your tax liability.