When property generates income in the form of capital gains. However, you need to make the right investments to get any tax benefits on it. When you sell a property, you either earn a short- (if held for less than three years) or long-term (if held for over three years) capital gains.
Long-term capitals gains are taxed at 20.6 per cent after indexation. You are taxed at 10 per cent without indexation only in the case of financial assets – mutual funds and shares. Indexation helps you inflation-adjust the cost. Or, indexation facto in inflation during the holding period by adjusting the cost of acquisition of the property upwards, thereby, bringing down the tax liability. For instance, the value of rupee ten years ago wasn’t the same as it is today due to inflation. So, if you are asked to pay tax on your profits derived from reducing actual cost from the sale proceeds, it would be unfair. Reason: The sale proceeds are derived from the current value of rupee whereas you paid as per the value ten years ago.
The Income Tax (I-T) Department releases the Cost Inflation Index (CII) each financial year. For calculating capital gains, the cost should be multiplied by CII of the year of sale and divided by the CII of the year of property purchase. This essentially adjusts or inflates the cost to current levels reducing the capital gains. Say a property was bought in the financial year (FY) 2000-01 for Rs 50 lakh. The same is being sold now for 2 crore. A simple subtraction would show a long-term capital gains of Rs 1.50 crore.
On adjusting for inflation the capital gains is Rs 1.03 crore. The CII for FY 00-01 was 406 and for the current year is 785.
If the cost is adjusted with the ratio, the revised cost is Rs 97 lakh, bringing the capital gains down to Rs 1.03 crore. Your net tax saving = Rs 9.6 lakh (20.6 per cent).
But, how to save this tax? Choose from the following –
Invest in tax saving bonds. These are issued by National highways Authority of India (NHAI) and Rural Electrification Corporation (REC). There is a three years lock-in and only up to Rs 50 lakh can be invested. If the entire gain is invested, it is fully exempted from tax. Investment of a lesser amount will grant a proportional deduction.
Buy another residential property. There are two points to note. Firstly, if you sell a residential asset, you have to invest the capital gains in a new property. If you sell a commercial property or a plot of land, the sale proceeds have to be invested. Capital gains could be much lesser due to indexed cost whereas, the net sale proceeds is net of brokerage and other incidental costs.
Secondly, the new asset has to be residential. When you sell a property – residential or commercial – the tax can be saved by investing (capital gains or net sale proceeds) in a new residential property only not commercial property or a plot of land.
Buying property is very different from investing in bonds. Financial investments need you to fill a couple of forms, sign those and hand over a cheque. But buying a house can be a much long drawn process. Apart from being a big ticket purchase, you need to identify a suitable property. You also need to check if the title is clear and the property is free of other encumbrance. All this due diligence is time consuming.
Hence, the law gives you two years, from the date of sale of a property, to identify another property and invest in it. In case of properties under construction, you get three years. However, before that file the tax return.
Now, if a property hasn’t been identified and purchased before the return has been filed or before the due date of filing tax returns, whichever is earlier, the money has to be deposited in a special account called Capital Gains Account Scheme or CGAS. Doing this shows that you intend to buy a property to save the tax on capital gains. Any withdrawal from CGAS should only be for payments to be made in favour of a new property to be bought.
Lastly, the new property purchased has to be held for a minimum period of three years failing which the capital gains arising from the sale of the new property together with the amount of capital gains exempted earlier will be chargeable to tax in the year of sale of the new property.
The writer is Director, Wonderland Consultants