How to save capital gain tax on sale of residential property?
Created on 19 Apr 2022
Wraps up in 5 Min
Read by 3.6k people
Updated on 11 Sep 2022
Taxes are something that no one enjoys. But what if I told you that there are some simple ways to save money on taxes while selling your most valuable asset, your own 'house'? Yes, there are some exemptions available to you under the Income Tax Act that allow you to earn a tax break on the sale of your home.
Isn't it fascinating? You don't need to be a CA or any other type of professional; all you need to do is follow a few simple procedures, and you'll be free of a large liability.
Let's look at some of the ways you might save money on taxes now.
What is Capital Gains Tax?
The profit realised on the sale of an asset for a consideration value greater than the asset's purchase price is referred to as capital gains. And the tax applicable on such gains is called capital gains tax.
The capital gains on the sale of a property can be calculated using a simple formula. The capital gains realised is calculated by subtracting the purchase price, stamp duty, improvement costs, and any other charges associated with the property from the net consideration price.
Types of capital gains
There are two types of capital gains-
1. Short term Capital Gains (STCG)
If a property is sold within 24 months from the date of its purchase date, the gain realised on the sale is referred to as a Short Term Capital Gain, and the tax on that gain is known as Short Term Capital Gains tax.
In the event of a property sale, STCG is applied at the Assessee's tax slab rate. STCG is added to the Assessee's total income and taxed according to the tax slab in effect at the time of the Assessment Year.
2. Long Term Capital Gains (LTCG)
If a property is sold after 24 months from the date of purchase, the gain realised on the sale is known as Long Term Capital Gains, and the tax imposed on such gain is known as Long Term Capital Gains Tax.
When a property is sold, LTCG is computed after providing the advantage of indexation, which adjusts the purchase price for rising inflation and then calculates capital gains. The LTCG is then taxed at a fixed rate of 20% plus a 4% cess, for a net rate of 20.8 per cent on the LTCG.
Methods to save capital gains tax on the sale of residential property
As a residential property is the prime asset of most individuals living in India, taxes paid on its capital gains can be heavy and discouraging to sell it. However, the government has granted some incentives, including exemptions from capital gains tax on the sale of residential property.
It has incentivised new-home buyers by allowing the entire purchase price to be tax-free in certain circumstances.
Today, let's look at some of the ways that we as people, may save money on taxes while selling our homes and make the most of prudent tax planning.
👉 Section 54
Under Section 54 of the Income Tax Act, The Long Term Gain arising from the sale of house property can be exempted.
For example, Mr Sharma bought a house on 1 May 2019, worth ₹1,00,00,000 and then sold it on 1 April, 2022 for ₹1,20,00,000. Realising a capital gain of massive 20 lakh rupees. Which, according to the IT act, would amount to a mammoth tax of ₹4,00,000.
But Mr Sharma is a clever individual who had done his tax planning beforehand. So to claim deduction u/s 54, he bought a residential house in another locality for the same ₹1,20,00,000. This allowed him to use the entire receipt in buying of a new Residential House, and he is exempted from the Rs. 4,00,000 tax that he would have to pay if he had not bought the new house.
Clever Mr Sharma! 😎
Let us now find out the conditions that we need to make sure of while selling an old property and buying a new house property to claim deduction u/s 54 -
1. The sale of property must result in a Long Term Capital Gain
2. Investment in a new House must be a residential property
3. The new house must be situated in India.
4. The new house should have been purchased one year before or two years after the date of sale of the property.
5. Amount of capital gains should be deposited in the capital gains account scheme if the new house is not brought in the present Financial Year.
If the entire capital gains are not utilised in buying a new house, then exemption is provided in that proportion.
👉 Capital gain account scheme
We may not want to buy another house quickly after selling one for a variety of reasons, including the belief that the housing market is now overpriced or the fact that we do not like any house currently on the market. However, if you desire to do so in the future, how will you be able to keep that money without paying taxes on it?
If you intend to buy a house with the proceeds from a sale in the future, the government permits you to park your capital gains in your bank's Capital Gain Account Scheme, where it will earn interest and can only be used to buy a residential house later.
👉 Section 54EC
There are some specified investment instruments in which an individual can park their capital gains realised from the sale of any property within six months from the date of sale. These Fixed Income Instruments give an interest rate of around 5-6%, and this interest income is liable to tax.
These fixed income instruments have a lock-in period of 5 years and a maximum limit of investment of Rs.50,00,000 in a single financial year.
Instruments on which the exemption u/s 54EC is available-
1. Rural Electrification Corporation Limited or REC bonds,
2. National Highway Authority of India or NHAI bonds,
3. Power Finance Corporation Limited or PFC bonds,
4. Indian Railway Finance Corporation Limited or IRFC bonds.
The Bottom Line
We hope that this blog has helped you be aware of how to save your taxes in a legal way. And also hope that this information might be helpful in better tax planning and have saved you some bucks.
Let us know in the comments below, if you have used any of the methods as mentioned above to save taxes. And do let us know if we missed something.
Your feedback is what encourages us to create better content each day!
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