In India, we love to buy properties, and often these purchases are partly funded by the sale of properties owned by our parents or grandparents. When we sell any property, whether it’s a house, shop, or land, it attracts taxes if we make a profit from the sale. This gain is calculated using methodologies provided by the Income Tax authorities, which can sometimes get complex. But don’t worry—let’s discuss each relevant concept in detail regarding the taxes levied when selling a property.
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What is Capital gains?
Section 45(1) of the Income Tax Act, 1961, stipulates that profits or gains arising from the transfer of a capital asset are taxable as capital gains in the year the transfer occurs. This is the fundamental rule governing capital gains taxation, ensuring that any profit from the sale or transfer of capital assets is appropriately taxed under the “Capital Gains” head of income.
What is Capital Asset?
Understanding what qualifies as a capital asset is crucial for determining tax liabilities related to capital gains. The term “capital asset” under Section 2(14) of the Income Tax Act, 1961, refers to any property held by an individual, whether connected to their business or not. This includes both tangible assets like land and buildings, and intangible assets like patents. However, some items are excluded from this definition, such as business inventory, personal effects like clothes, rural agricultural land, and certain types of bonds.
How much tax is levied on Sale of property?
It depends on multiple factors, mainly the tax rates, buying price, additional expenses incurred on the property, and the holding period of the asset.
Let’s understand each of these:
- Holding period:
If a property is held for 24 months or less, it is considered a short-term holding, and if it is held for more than 24 months, it is classified as a long-term holding. Both these types of holdings are subject to different tax rules.
For e.g. Ravi buys an apartment for Rs. 50 lakhs and considers two potential selling points to understand the impact of holding periods on capital gains classification. If Ravi decides to sell the apartment 18 months after purchasing, any gain from the sale is classified as a short-term capital gain, as the property is being held for less than 24 months. Conversely, if Ravi waits and sells the apartment 30 months after purchase, the gain qualifies as a long-term capital gain, since the property was held for more than 24 months.
- Buying price:
Generally, the purchase price is deducted from the sale price to calculate the gain from the sale transaction. Additionally, income tax rules provide the benefit of indexation, which means the purchase price is adjusted upwards to account for the impact of inflation.
- Improvements in property:
This includes all expenditures incurred in making any additions or alterations to the capital asset by the assessee, after it was acquired by him. These improvements must be of a capital nature, meaning the expenditure must add value to the asset, extend its life, or enhance its utility, and must not include expenses for routine repairs or maintenance.
Tax Rates:
- Short-Term Capital Gains (STCG): STCG is added to your total income and taxed as per your applicable income tax slab.
- Long-Term Capital Gains (STCG): LTCG of 12.5% will be levied
The Finance Act 2024 has introduced tax relief for individuals on their long-term future investments on the other hand removed the indexation benefit, effective from July 23, 2024:
- The tax rate has been reduced from 20% to 12.5%.
- However, real estate owners who purchased property prior to the amendment date have the option to pay 20% tax with the benefit of indexation.
Relief for Property Owners:
Property owners have two options for calculating long-term capital gains (LTCG) tax when selling immovable property. They can choose the option that results in a lower tax liability:
- Option 1: Calculate LTCG tax at 20% with the benefit of indexation, which adjusts the purchase price for inflation.
- Option 2: Calculate LTCG tax at a flat 12.5% without applying the indexation benefit.
Tax Amount:
STCG/LTCG Tax = Tax rate ( Sale Price – Cost of Acquisition – Cost of Improvement – Transfer Costs)
Case Study:
Ravi, a software engineer, ventures into real estate by purchasing an apartment in Bangalore for Rs. 50 lakhs. He meticulously plans his future actions, considering various factors such as the holding period, costs of improvements, and changing tax laws, to optimize his return on investment.
Buying the Property:
In January 2022, Ravi buys an apartment for Rs. 50 lakhs. Considering future potential, he also invests Rs. 5 lakhs in capital improvements over the next year, enhancing the property’s value, utility, and lifespan. These improvements include a kitchen remodel and the addition of an energy-efficient heating system.
Scenario Analysis:
Ravi contemplates two scenarios to decide the optimal selling time, influenced by tax implications and market conditions:
- Short-Term Holding (18 months later, July 2023):
- Ravi considers selling the apartment. At this point, the market value of the apartment has increased to Rs. 60 lakhs.
- Tax Treatment: As the property is sold within 24 months, the gain of Rs. 5 lakhs (Rs. 60 lakhs – Rs. 50 lakhs – Rs. 5 lakhs improvements) is considered a short-term capital gain. This gain is added to Ravi’s total income and taxed according to his income tax slab, which is 30%.
- Tax Payable: Rs. 1.5 lakhs (30% of Rs. 5 lakhs).
- Long-Term Holding (30 months later, July 2024):
- Ravi waits a bit longer and sells the apartment when its value reaches Rs. 70 lakhs.
- Tax Treatment: The sale now qualifies as a long-term capital gain because the property was held for more than 24 months.
- Options for Tax Calculation:
- Option 1: Calculate LTCG tax at 20% with indexation benefits. Assuming the indexed cost of acquisition and improvements is Rs. 60 lakhs, the taxable gain is Rs. 10 lakhs (Rs. 70 lakhs – Rs. 60 lakhs).
- Option 2: Calculate LTCG tax at a flat rate of 12.5% without indexation. The taxable gain is Rs. 15 lakhs (Rs. 70 lakhs – Rs. 50 lakhs – Rs. 5 lakhs improvements).
- Best Option: Ravi chooses Option 2 for a lower tax liability.
- Tax Payable: Rs. 1.875 lakhs (12.5% of Rs. 15 lakhs).
Ravi’s strategic planning allows him to understand the nuances of real estate investment and tax planning. By considering different selling points and improvements made to the property, he is able to significantly influence his capital gains tax liability. The scenario of a long-term holding becomes more advantageous financially, thanks to the reduced tax rate of 12.5% introduced by the Finance Act 2024, despite the removal of indexation benefits. This example signifies the importance of understanding tax laws and their implications on investment returns.
Tax Saving Options on LTCG
There are a few exemptions available to reduce long-term capital gains, such as:
- Investment in Residential Property: If you sell your residential property and proceeds from long-term capital gain are invested in another residential property within the specified timeline, then the amount of capital gain or cost of new property, whichever is lower, shall be exempted under Section 54 of Income Tax Act.
Timeline:
The new property must be bought either one year before or two years after the sale of the original property, or
It must be constructed within three years from the date of transfer of the original property.
Note: The maximum amount of deduction will be ₹10 Cr.
- Investment in Residential Property from capital gains on sale of assets other than residential property: All the conditions including timeline and limit to claim deductions are same as above except that the capital gain should be from the transfer of assets other than residential property under section 54F of Income Tax Act.
- Investment in Bonds: If you invest the long-term capital gains from the sale of immovable property in specific bonds (e.g., NHAI, REC, or other bonds specified by the central government) within six months. Then exemption is available up to a maximum amount of Rs.50 lakh under section 54EC of Income Tax Act.
Note: These bonds have a lock-in period of five years. If bonds are sold before completion of 5 years, then exemption will be treated as capital gain in the year of sale.
Conclusion
By understanding how to apply updated tax rates, utilize indexation benefits, and take advantage of available exemptions, you can resolve all your doubts about taxation on your last property sale and discover tax-saving strategies to maximize your savings and optimize financial growth. Smart tax planning not only reduces liabilities but also enhances your overall financial strategy.
To address all your doubts about property sale taxation and tax-saving strategies, and to optimize your taxes, download the 1 Finance app and book a consultation with a qualified financial advisor for a seamless, hassle-free tax planning experience.
