Explained: How to minimise capital gains tax on property, equity and MFs

During Budget 2023, Finance Minister Nirmala Sitharaman set a ceiling of Rs 10 crore for the long-term capital gain tax deduction for reinvestment in residential properties under Sections 54 and 54F of the Income Tax Act.

 Earlier, there was no maximum limit. The new limit became applicable from April 1, 2024, and will apply in relation to the assessment year 2024-25 and subsequent assessment years. The government said that the fundamental purpose of these sections were being undermined by several high-net-worth assessees who were making claims of significant deductions by purchasing  expensive residential properties. 

Capital gains refer to the money you make when you sell a capital asset. The Capital Gains Account System enables people to hold onto their capital gains in this account until they can be reinvest into the assets listed in Sections 54 and 54F of the Income Tax Act, 1961, thus protecting their long-term capital gains.

"The sale of capital assets may lead to capital gains and these gains may attract tax under the Income Tax Act. To save tax on these capital gains, a few capital gains exemptions/deductions are available. Thus, one needs to plan benefits, considering all the relief available under the law," said Archit Gupta, founder of ClearTax.

Questions like who can get such deductions, what amount of deductions, what assets need to be sold, what assets need to be purchased, and in how much time are answered below:

Reinvest: According to Section 54 of the Indian Income Tax Act, if you sell a residential property and reinvest the capital gains into buying another residential property within a specified period (within 2 years for purchase, or construct a new property within 3 years), then the capital gains from the sale of the initial property can be exempted from tax.

The cost of the house when you bought it was Rs. 20 lakh, and you are selling it for Rs. 42 lakh. In this case, you make a profit of Rs. 22 lakh and you are liable to pay long-term capital gains tax on this profit amount. According to rules, you will have to pay 20% LTCG tax in addition to around 3% surcharge and cess. However, you will be exempt from paying this tax if you buy another residential property with the money you have earned from the sale of the old property.

CGAS investment

"If the capital gain is not reinvested until the date of tax filing, it can be deposited in a Capital Gains Account Scheme (CGAS) and should be used for the above purposes within the specified time frame," said Ankit Jain, Partner, Ved Jain and Associates.

If the money is deposited in this account, you need to use it within 2 years (in case of purchase of a new house) or 3 years (in case you are constructing a new house).

You have to open the account before the deadline to file I-T return, and the money must be used only to buy a residential property. If the money is not utilised in buying a house within the time limit, the capital gains will be subject to tax.

When you cannot escape the capital gains tax
BankBazaar explains the exceptions in this case:

1.  You can get an exemption only for the purchase of 1 house. If you are using the capital gains to buy more than 1 house, you will be able to claim exemption only for the cost of 1 house.
2. You can get an exemption under Section 54 only if you are buying a house in India. Any residential property purchased outside the country will not get you any exemption from paying LTCG tax.
3. You cannot sell the new house bought from the gains of sale of the old house until 3 years after the purchase or completion of construction. This means that if you sell the new house before 3 years of its purchase/construction is completed, the benefit received by you under Section 54 will be revoked and you will have to pay the LTCG tax.

Sale of agriculture land: Section 54B of the Income Tax Act also provides an exemption on the capital gains arising from the sale of agricultural land. Here the taxpayer should purchase another agricultural land within a period of two years from the date of transfer of old land.

Sell Your Stocks, Buy a House

Sale of long-term assets other than a house - such as land, commercial buildings, stocks, securities, bonds, vehicles, patents and trademarks, jewellery, machinery - also give you capital gains." For example, you want to sell stocks that you have been holding for more than 1 year (in case of equity funds) or 3 years (in case of debt funds). You bought the stocks for Rs 15 lakh, and sell it for Rs. 23 lakh. In this case, you are making a capital gain of Rs. 8 lakh. This amount can be exempt from taxation if you invest it in buying or constructing a new residential property," said BankBazaar.

 Tax-Loss Harvesting: Tax-loss harvesting is a method used by taxpayers to minimize their capital gains tax liability. If an investor holds a security that has experienced a loss, they can sell it to "realize" or "harvest" that loss. The realized loss can then be used to offset any capital gains they have from other investments, thereby reducing their overall taxable income. 

If an investor holds shares or mutual funds for over a year, the profits are long-term capital gains. For any shorter duration, it is treated as short-term capital gains. The long-term capital gains on shares or equity MFs up to Rs 1 lakh are tax exempted. Any gains above Rs 1 lakh are taxed at 10%. On the other hand, short-term capital gains attract a flat 15% tax, irrespective of the income slab of the investor. 

"To optimize LTCG tax, an investor can use tax harvesting. For example, if she had invested Rs 5 lakh in an equity mutual fund on  1 March 2023, and it grew to Rs 5.50 lakh on 5  March 2024, the gains qualify for LTCG. Since the gain is less than Rs 1 Lakh, there is no tax liability. 

Now the investor can sell these units on 5 March 2024 and use the entire proceeds to buy back the units on the same day. The new buying price now becomes the initial investment. On 6th March 2025, if the corpus grows to Rs 6.2 lakh, the LTCG for FY 26 will only be Rs 70,000. Hence, there will be no tax on the LTCG.," said  Ajinkya Kulkarni, Co-Founder and CEO, Wint Wealth

Without tax harvesting, the initial investment of Rs 5 lakh would have become Rs 6.2 lakh in two years. The Rs 1.2 lakh LTCG would have meant Rs 20,000 taxable gain. At a 10% rate, the tax saving through harvesting is Rs 2000."

Investment in Specified Bonds: If you are selling a long-term asset but do not plan to invest in a new house, there is another way to save LTCG tax. You need to invest the capital gains in notified bonds. These bonds are usually issued by government bodies such as Rural Electrification Corporation (REC) and the National Highways Authority of India (NHAI), and the interest rate is 6%. The interest gained is not exempt from tax.

"The investment in these bonds has a lock-in period of 5 years, and the maximum limit of investment that can be claimed as an exemption is Rs 50 lakh in a financial year, " said Ankit Jain, Partner, Ved Jain & Associates.

"The eligible bonds cannot be transferred or pledged as security during the holding period of 3 or 5 years. But, the bonds can be sold or redeemed after the completion of the holding period. If the bonds are redeemed or sold before the completion of the holding period, the LTCG tax exemption claimed will be reversed and the exemption claimed earlier shall be directly taxable as LTCG," explained Wint Wealth.

Start-up exemption: To promote investments in start-ups, the Finance Act 2021 introduced Section 54GB. This provision allows individuals to claim an exemption on long-term capital gains if the gains are invested in eligible start-up companies. "The investment must be made within six months from the date of transfer of the original asset, and certain criteria regarding shareholding and lock-in periods apply," said CA Mahima Vachhrajani.

The loopholes
Apart from the various exemptions provided by the Income Tax Act, 1961, Shashank Agarwal, Advocate, Delhi HC, explains certain loopholes which can enable a person to escape tax on capital gains in the following two instances:
 

i. Section 47 which provides for the transactions which are not regarded as a ‘transfer’ and thus are not chargeable as capital gains. It includes the transfer of a capital asset under a gift or will or an irrevocable trust. Therefore, transferring the asset and giving it the impression of the above-mentioned modes can avoid capital gains tax liability on the transfer.

ii. The Act provides for indexation benefit on the acquisition of property and cost of improvement of the property during the holding period. The older the event of acquisition or improvement in property, the more the indexation benefit. This is one area which is often exploited by the assessees by showing bills and invoices in respect of improvement or repair works even though no such work may have happened.