Selling a residential house property can be a significant financial move, but it often comes with capital gains tax implications. To help you maximize your returns, the Income Tax Act of India offers valuable exemptions under Section 54 and Section 54EC specifically designed for individuals who have earned capital gains from the sale of residential house properties. In this blog post, we’ll delve into these exemptions, providing a step-by-step guide on how to save taxes while making the most of your real estate investments.

Understanding Capital Gains on sale of house property

When you sell a residential house property, the profit you make from the sale is known as capital gains. In India, capital gains are categorized as either short-term or long-term, depending on the duration of ownership.

Short-Term Capital Gains (STCG): If you sell the property within two years (24 months) of acquiring it, any profit earned is considered short-term capital gains. STCG is taxed at your regular income tax rate.

Long-Term Capital Gains (LTCG): If you hold the property for more than two years (24 months) before selling it, the gains are classified as long-term capital gains. LTCG on the sale of a residential property is subject to specific tax treatment.

You can learn more about capital gains tax, how it is calculated and more details in this blog – decoding-taxation-on-capital-gains

Exemptions available on capital gains from sale of residential house property

To encourage long-term investments in residential real estate, the Income Tax Act provides exemptions under sections like 54 and 54EC, allowing you to reinvest the LTCG into another residential property or certain Bonds to reduce or eliminate the tax liability. However, if you don’t meet the conditions for these exemptions, LTCG is taxable at a flat rate of 20% with indexation benefit.

Section 54 – Buying a new house against the one sold

Eligibility Criteria
To qualify for an exemption under Section 54, you must meet the following conditions:

The property sold must be a residential house or property and the capital gain should result from the sale of this residential property.
The property should have been held for more than two years.
You must reinvest the capital gains in the purchase or construction of another residential property.
You can claim this exemption by investing the amount in maximum 2 residential properties.

Exemption Amount
The exemption under Section 54 is limited to the amount of capital gains reinvested in the new residential property. If the entire capital gain is reinvested, you can claim a complete exemption from capital gains tax.
In the budget of 2023, the limit for exemption has been capped at Rs. 10 crores.

Time Limit for Investment
To claim this exemption, you must invest in the new residential property either one year before the sale of the old property or within two years after the sale. In the case of constructing a new property, the construction must be completed within three years.

Partial Exemption
If you cannot reinvest the entire capital gain, the remaining amount is taxed as long-term capital gains. However, you can still claim a partial exemption based on the proportion of the capital gain invested in the new residential property.

Section 54EC – Investment in REC or NHAI Bonds

 

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Section 54EC is applicable to individuals and Hindu Undivided Families (HUFs) who have earned long-term capital gains from the sale of any property (land/ building). This also includes residential house property

Eligibility Criteria:

The property sold must be a land or building or any part thereof (including residential properties) and the capital gain should result from the sale of this asset.
The asset should have been held for more than two years.
You must reinvest the capital gains in the specified bonds of NHAI or REC

Investment in Specified Bonds:

To claim the exemption, you need to invest the capital gains in specified bonds issued by government entities, namely the National Highways Authority of India (NHAI) or the Rural Electrification Corporation (REC).
These bonds are commonly known as “54EC Bonds.”

Exemption Amount:

The exemption under Section 54EC is limited to the amount invested in these specified bonds, subject to a maximum investment limit of Rs. 50 lakhs in a financial year.
The entire capital gain amount can be invested to claim the maximum exemption.

Lock-in Period:

The invested amount in 54EC Bonds has a lock-in period of five years from the date of investment. During this period, you cannot sell or transfer the bonds.

Interest Income:

While the invested amount is locked in for five years, the bonds also generate interest income. This interest income is fully taxable.

Time Limit for Investment

Be mindful of the six-month window to invest in these bonds to claim the exemption. Missing this deadline may result in a tax liability.

Additional Considerations:

If you redeem the bonds before the completion of the lock-in period, the capital gains tax exemption will be reversed, and the gains will become taxable.

Capital Gains Account Scheme (CGAS)

Eligibility Criteria
If you are unable to reinvest the capital gains immediately, you can deposit the gains in a Capital Gains Account Scheme with a designated bank before the due of filing your ITR.

Exemption Amount
You have up to two years to utilize the funds for purchasing or constructing a new residential property and claim the deduction under section 54. Until then, the deposited amount is exempt from capital gains tax.

Points for effective tax planning for real estate

 

Joint Ownership with Family Members

Another strategy to save on capital gains tax is to consider joint ownership of the new residential property with family members, such as your spouse, children, or parents.
In such cases, each joint owner can claim an exemption based on their share of the capital gains. This can help distribute the gains among family members and reduce the tax burden on each individual.
Also at the time of sale of such property, the capital gains will be distributed in the name of each individual.

Construction of a New Property

If you choose not to purchase an already constructed property, you can opt to construct a new residential house to claim an exemption.The exemption amount remains the capital gains reinvested in the new residential property. This also qualifies as exemption under section 54 of the Income Tax Act.

Ensure that the construction is completed within three years from the date of sale to claim the exemption.

Reverse Mortgage Scheme

For senior citizens looking to downsize or release equity from their residential property, the Reverse Mortgage Scheme can also be an option. The amount received under this scheme is considered a loan and not a taxable income. It is exempt from capital gains tax.

Conclusion

When you sell a residential house property, it’s essential to be aware of the tax-saving options available under Section 54 and Section 54EC of the Income Tax Act. These exemptions can significantly reduce your tax liability, allowing you to reinvest your capital gains in another residential property or Bonds and maximize your wealth. Remember to consult with a qualified chartered accountant or tax expert to ensure you meet all eligibility criteria and follow the correct procedure when claiming these exemptions. By doing so, you can make the most of your real estate investments and secure your financial future.

Disclaimer: This blog is intended for informational purposes only and should not be considered as professional tax advice. Please consult a tax expert for specific guidance tailored to your individual circumstances.

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