What is Capital Gain?

Capital gains tax on the sale of residential property is most unexpected tax which you pay because you rarely consider it before selling a property. Any profit or gain which you get from the sale or transfer of a capital asset will be called as capital gain. Capital asset could be anything from your property, any kind of security, jewellery, archeological connections, drawings, paintings, sculptures or any kind of art.

In case of selling of a residential property, capital gain can be categorized under two sections i.e. short term capital gain and long term capital gain. In case, you have sold the house within 3 years of its purchase, then the gain will be considered as a short-term capital gain and in case you have sold the house after 3 years of its purchase, then the gain from the sale of the house will be considered as a long-term capital gain.

In order to calculate short-term capital gain, you need to make certain deductions such as cost of its acquisition, expenses incurred during the process of sale and cost of improvements, if any from the total sale price. Calculation of long-term capital gain is similar to that of short-term, however, you need to include indexed cost of acquisition from the total sale price and also can claim certain exemptions in order to save on capital gains tax. Also, short-term capital gains are taxed as per income tax slab rates whereas long-term capital gains are taxable at the rate of 20%. Capital gains tax are quite a big tax however with a little bit of smart planning you can save capital gain tax on sale of your residential property.

How to Save Capital Gain Tax on Sale of Residential Property?

How Can You Save Capital Gains Tax on Sale of Residential Property:

  • Use Indexation While Calculating Capital Gains: The cost inflation index basically depicts the annual increase in the inflation and thus helps you in increasing the cost of your property with the rise in inflation i.e. in case if the cost inflation index has increased from 800 to 1000 in 3 years, you can increase the cost of your property from 80 lakh to 1 crore in the same period and since the price of your residential property is inflated, the capital gains on it reduces and thus you pay less capital gains tax on it. Calculation of capital gains is quite simple wherein you just have to subtract the cost of the property from the sale price of the property, however with the introduction of indexation, you can use the below mentioned formula to calculate the capital gains:

    Capital gains after indexation = Sale price of the property – Indexed cost of the property

    Indexed cost of the property = Cost of the property * Cost inflation index of the year your property was sold/Cost inflation index of the year when property was bought).

  • Buy or construct a residential house – Section 54 and 54F: In case you have sold your old house and have bought a new one, you are not making any income on the same; however you might end up paying capital gains tax on it. However, Section 54 gives you some relief in case you have bought a new residential house from the sale proceeds of your old residential house. Rules of Section 54 and 54F are mentioned as below:

    • You can buy a new house one year before selling off your old one.
    • You can construct a new house within 3 years of selling your old one or you can buy a new one till 2 years from the sale of the old house.
    • In case you have spent the entire capital gain on the purchase of your new residential property then you don’t have to pay any capital gains tax.
    • The exemption rules are applicable only for one house.
    • In case you have sold the new residential house within 3 years of its construction, the capital gains exemptions will be withdrawn.
    • Under Section 54F, the amount of exemption would proportionate to the sale and purchase price of the new house.
    • Under Section 54, the amount of exemption would be lower of capital gains or cost of new house.
  • Capital Gains Bond Under Section 54EC: Capital gains bond is basically for those who have already sold their houses and hence can’t take the benefits of Section 54. They can invest in the capital gains bond and avail the following features of the bond:

    • Capital gains bond give exemption from capital gains tax.
    • You have the option of investing your entire capital gains into this bond. However, if you have invested lesser than what you have realized as capital gain, then only the proportionate capital gains would be exempted from tax.
    • It gives you the annual interest rate of 6%, which is lesser than the current fixed deposit rate.
    • The interest of capital gains bond is taxable; however TDS is not applicable on it.
    • You must invest the capital gains into this bond within 6 months of getting the same.
    • Money invested in the capital gains bond gets locked for 3 years and after 3 years you don’t get any interest.
    • You need to invest minimum Rs 20,000 in the bond and once invested; the bond cannot be pledged or sold.
  • Capital Gains Account Scheme: You can opt for this option in case you cannot invest in a new residential property before filing your income tax return wherein you can invest money under this scheme for a period of 3 years and use the capital gains for the purchase or construction of a new residential property. However, you need to declare the investment in the capital gains account scheme in your income tax return. The main features of capital gains account scheme is as below:

    • You can open the account only with certain banks and bank such as cooperative and regional bank are not eligible under this scheme.
    • There are two types of account under this scheme and you can choose one depending on your requirement. Account A is similar to a savings account and you can choose the same in case you want to build the house, whereas Account B is like a fixed account which you can use in case you want to buy a property after a year.
    • The interest rate is fixed periodically by the RBI.
    • The interest rate on the capital gains is taxable and TDS is deducted as per the provisions.
  • Capital Loss Set Off: Under this, you can save on your capital gains tax by setting off the capital gains against the capital loss you have incurred earlier. However, you need to ensure that the capital loss is from the earlier date and it cannot be carried forward for more than 8 years. Also, short term capital gains can be set off against the short term capital loss whereas long term capital gain can be set off against long term capital loss.