Selling a property has tax implications. Since the potential gains from a property sale can be high, the subsequent tax paid on it could be high as well. Similarly, purchasing a property can also lead to potential tax benefits. The benefits related to the repayment of a housing loan are well known. However, what needs to be kept in mind is that the tax benefits depend on the holding period and one needs to match the benefits with the holding period to ensure no higher tax liability arises in future.
Sale of property
Two main aspects need to be considered when the sale of the property is undertaken. The first deals with the calculation of the quantum of the gains that have been earned on the property as this would directly impact the tax to be paid. The time period of the holding becomes vital here because it is used for the classification of the gains into short term capital gains or long term capital gains. The second aspect deals with the tax deductions that have been taken for the purpose of the repayment of the housing loan. If the holding period of the property does not cross the specified time limit then these deductions might have to be reversed.
Capital gains: Short or long?
The holding period is significant for the purpose of determining the nature of capital gains earned on the sale of property. Short-term capital gains is applicable if the holding period is less than three years. These gains are added to the income of the individual and then taxed at the applicable rate. This could very well mean you may have to end up paying the highest marginal tax rate at 30 per cent plus cess. Most people would end up paying this rate of tax on their short-term capital gains. On the other hand, long-term capital gains are taxed at 20 per cent plus cess with the benefit of indexation, reducing the overall tax burden considerably.
This means that the individual has to hold the property for a minimum period of three years to ensure that the gains from the transaction qualify as long-term capital gains and the lower rate applies. But even this tax can be avoided if the individual reinvests the capital gain amount in another property or in specified bonds within six months from the date of sale.
Those who cannot immediately purchase another property can park the amount earned by selling the property in a Capital Gain Account Scheme (CGAS) in any nationalised bank within six months of selling the property. This amount must be used for buying a new house within two years of parking the amount in the account or used for constructing a new house within three years of parking the amount in CGAS.
Benefit for repayment of housing loan
The Income Tax Act allows an individual to take the benefit of deduction on the interest and capital paid on the Equated Monthly Instalment (EMI) to the financial institution on the housing loan. The amount under these heads is totalled for the year and the individual can take a deduction under different sections. The interest portion is available for deduction under Section 24 while the repayment of capital is available for deduction along with the other eligible investments under Section 80C.
However, if an individual takes the benefit under Section 80C, he needs to ensure that the house property is held or owned for a specified time period; else the benefit will have to be reversed and this would end up affecting the past years for which deduction has been claimed. What is important to note is that the time period for holding under this section is five years, which is two years more than that specified under the capital gains provisions.
This means a benefit claimed under Section 80C may be reversed in the year in which the property was sold, if the time period of holding the property is less than five years from the date of purchase. Individuals need to plan ahead in order to avoid this kind of situation and ensure the holding period is achieved. If they plan to sell the property earlier, then it is better that they do not take the benefit of the repayment of the housing loan capital.
Individuals need to ensure that the holding period of a property before its sale is at least three years in order that the sale qualifies as long-term capital gains. This is important as the amount here can be quite substantial.
For example, a property is purchased in FY1995-96 for Rs 20 lakh and sold in FY2012 for Rs 80 lakh. Net gains for the sale work out to Rs 60 lakh but long-term capital gains computed after accounting for indexation benefits amount to about Rs 24 lakh. This bears out the significance of holding the property for at least three years, and avoiding paying short-term capital gains tax.
COUNTING YOUR GAINS
- Short-term capital gains are added to the income of the individual and taxed at the applicable rate
- Long-term capital gains are taxed at 20% with indexation
- Interest portion of loan is available for deduction under Section 24
- Repayment of capital is available for deduction under Section 80C
- Benefit claimed under Section 80C may be reversed if the holding period is less than 5 years