Selling a property after holding it for at least 2 years attracts the Long-Term Capital Gains (LTCG) tax. Usually, a property price goes into lakhs or even crores of Rupees, and this rax charged at a flat rate of 20 percent is a considerable sum of money.
However, the adoption of certain ways can massively reduce your tax liability and even render it to zero.
In this article, we will discuss various methods of doing so. These methods are perfectly legal.
Before discussing the different methods, let us see how the Long-Term Capital Gains (LTCG) tax is calculated because understanding this is the key to tax liability reduction.
LTCG Calculation and Indexation
The capital gain tax is to be paid on the profit earned after considering the inflation and indexed acquisition cost. Now, what is the ‘indexed acquisition cost’ of a property?
Indexation is a technique to adjust the asset cost according to the inflation index. It will increase your cost and reduce your gains and thereby, tax liability.
If you have bought a property for Rs.35 lakh and sold it after a certain period for Rs.105 lakh, your profit is Rs.70 lakh. But that profit is not the capital gain. You have to consider the cost inflation indexation and that considerably reduces your capital gain liability.
Reserve Bank of India derives a number each financial year and it takes into account the prevailing prices for the particular financial year.
After you have determined the indexation factor, you have to calculate the indexed cost of acquisition which is the actual purchase price multiplied by the indexation factor.
The capital gain can be further reduced by adding your expenses for property upgrades, expense of transfer, and maintenance.
For property owners to leverage the indexation benefit, they should hold the property for at least two years, as this benefit is only available for long-term capital gains.
Avail Indexation Benefit
An effective method to reduce the tax on the sale of a residential property is to take advantage of the indexation benefit.
Indexation adjusts the purchase cost of the property to account for inflation. This effectively lowers the amount of capital gains and subsequently the tax on it.
Jointly Own Your Property
If you have a jointly owned property, capital gains from the sale can be divided amongst the co-owners, depending on their ownership share.
By doing this, each co-owner can make the most of the basic exemption limit available to them, thereby possibly reducing the overall tax liability.
Add Expenditure Used to Renovate the Property
Keep receipts of all the expenses made on enhancing or renovating it. These expenses can be added to the cost of the house and help lower the taxable capital gain amount.
You can also deduct expenses like brokerage fees from the sale price thereby reducing LTCG tax amount.
Buy New Property
Long-term capital gains are exempted from taxation (under Section 54 of the Income Tax Act, 1961) for individuals and Hindu Undivided Families on the sale of a house property if:
- The capital gains are used to purchase or construct another house.
- The new house is purchased one year before or two years after the sale of the old house.
- The new house was constructed within three years after the sale of the old house.
- Only one additional house property is purchased/constructed.
- The property being bought/developed is within India’s national borders.
- You don’t sell the new house for three years after taking possession of it.
- If the cost of the new property is less than the sale amount, the exemption then only applies proportionately. The remaining money can be re-invested under Section 54EC in under six months.
Buy a New Residential Property
You can claim an exemption (under Section 54 of the Income Tax Act, 1961) when you sell a non-residential property but use the proceeds to acquire a new residential property
However, there are certain conditions.
- The new house must be purchased either one year before the sale or two years after the sale, or it should be constructed within three years post-sale.
- For full exemption, the entire sale proceeds must be reinvested. If only the capital gain is used, then the exemption is granted proportionally.
- While claiming this exemption, the seller should not have more than one residential property, excluding the newly bought one.
Invest in Bonds
As you can see, there are various ways of reducing LTCG liability or even claiming complete exemption. However, there can be cases when a property seller is not keen on reinvesting the proceeds into another property.
In such an event, the seller can invest in government-specified bonds and claim exemption under 54 EC of the Income Tax Act, 1961.
Make sure to invest within six months of the property sale to claim this benefit. These bonds have a lock-in period of 5 years.
Invest in the Capital Gain Account Scheme (CGAS)
If you are not able to purchase a suitable house or construct one or can not find a suitable bond immediately, then you can invest in CGAS of public banks for that assessment year. While filing income tax returns, you can claim exemptions for money in CGAS.
However, the deposited amount in CGAS should be utilized within 3 years, or else you will be taxed for that amount.
Reinvest Gains into Shares of a Manufacturing Company
There is also a provision wherein any individual can reinvest Long-Term Capital Gains from the sale of a residential property into the shares of an eligible company that is engaged in manufacturing activities and claim exemption under section 54 GB of the Income Tax Act, 1961.
However, the limit for such reinvestment is Rs 50 lakh with the investor having to acquire more than 25% of the voting rights or 25% of the share capital in an Indian MSME Company.
Apart from the methods stated above, one can also adjust losses from sales of mutual funds or shares with capital gains on property sales. Moreover, this approach can be useful in rebalancing one’s portfolio. If you are interested in a detailed discussion on how you can save on LTCG liability on property sales, give us a call.