WHAT IS CAPITAL GAIN TAX AND ITS TYPES?  HOW TO SAVE CAPITAL CAIN TAX ON SALE OF PROPERTY

What is Capital Gain Tax?

You sell an asset, must pay tax on the profit earned it. This profit is called Capital Gains. The tax paid on this capital gain is called capital gains tax.

Types of Capital Gain Tax

It has two types 

1, Short term capital gains tax:

If you sell the asset within 24 months from the date of purchase. 

2, Long term capital gains tax :

If you sell the asset after 24 month from the date of purchase


5 Ways to Save Capital Gains Tax on Sale of Property

The capital gains tax on the property sale is most unexpected tax. You rarely factor in the capital gains tax before selling a property. But it is a big tax. The long term capital gains tax on the property is levied at the rate of 20%. The short term capital gains tax add up to your taxable income.

Do you consider this tax while investing in the property? Do you factor this tax liability while comparing the property investment with other investment? If you make money from selling the property, you have to pay the tax. While investment in the share market does not attract any tax after one year. However, you can save all of your hefty capital gains tax. There are 5 ways to save capital gains tax arising on the sale of property.

1. Use Indexation While Calculating Capital Gains

The capital gains tax rate on property sale is 20%. Generally it goes in lakhs. But, this tax liability can be reduced substantially by using cost inflation index.

The cost inflation index depicts the yearly increase of the inflation. Using this index, you can also inflate the cost of property with the rise of inflation. It mean if cost inflation index rose from 500 to 700 in three years, the real cost of property can be increased from 50 lakh to 70 lakh in the same period.

It also means that, if the price of property increases corresponding to the cost inflation index. You are not making any profit in real sense. This is how inflation eats up the appreciation of our investment.

Therefore, to get real current purchase value of the property we should inflate in corresponding to the cost inflation index. Because of the inflated cost of the property, the capital gains reduces. It means you have to give less capital gains tax.

Income tax department releases the cost inflation index annually. For this index the base year is 1980-81. The general prices of 1980-81 was given an index of 100. With the price rise this index of 100 increased gradually. In 2015-16, the cost inflation index reached up to 1081. You can say that general prices rose 11 times in 35 years (1081/100 = 11). Hence, through the use of cost inflation index table, you can reduce the capital gains substantially.

Calculation of Capital Gains Using Cost Inflation Index

The calcualtion of capital gain is very simple. It is just the profit on sale of your property. It means you have to just subtract the cost of the property from the sale price of property.

Capital gains = Sale price of the property – Cost of the property

But the use of inflation index changes the cost of the property. To get the cost of property after using the indexation, the following formula is used.

Indexed cost of property = Cost of the property x (cost inflation index of the year when property is sold /cost inflation index of year when property was bought )

Hence, actual capital gains would be as following.

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

Example

Shyam buys a house of for 30 lakh in May’ 2009, after 4 years he sells it for 45 lakh. What would be his capital gain ?

To get the real capital gains we have to use the indexed cost of acquisition. To calculate the indexed cost if acquisition we need capital gains index of 2009 and 2013. You can get this data from the cost inflation index table.

Cost inflation index of 2009-10 = 632

Cost inflation index of 2013-14 = 939

The indexed cost of property = (939/632) x 30,00,000 = 1.486 x 30,00,000

The indexed cost of property = 44,57,278

Capital gains = 45,00,000 – 44,57,278 = 42,722

Hence, the capital gains is Rs 42,722 instead of Rs 15 lakh. The capital gains tax on 15,00,000 would have been 3 lakh (15,00,000 x 20%) but because of cost inflation index it has become only Rs 8,544.

2. Buy  or Construct A Residential House

Suppose you wanted to change your residence due to some reason, hence, you sell your old house. From the sale proceeds of your old house you purchase another house. In this case your objective is not to earn income by sale of old house but to acquire another suitable house. In this case, if you become liable to pay income-tax, then it would be a hardship on you.

Section 54 gives relief from such a hardship. Section 54 gives relief to a taxpayer who sells his residential house and from the sale proceeds acquires another residential house. You can also save capital gains tax if the sold property is not a residential property. Under section 54F, the capital gains is exempted if sale proceeds of non residential property is invested in a residential property.

Rules of Section 54 and Section 54F

·         The capital gains from sale of a property can be set off against the purchase of new residential house.

·         If you use total capital gain for the purchase of new property, there would not be any capital gains tax.

·         You can buy a new house one year before the sale of old house.

·         You can buy a new house till 2 years from the sale of old house or you can construct a house within 3 years .

·         The exemption is available for one residential house.

·         You can’t sell the new house for next 3 years. Else, the capital gains exemptionswould be withdrawn. The 3 years is calculated from the date of acquisition or completion of work of the new house.

·         Under section 54, the amount of exemption would be lower of capital gains or cost of new house.

·         Under section 54F, the amount of exemption would proportionate to the sale price and purchase price of the new house.

3. Capital Gains Bond Under Section 54EC

It is one of the most popular method to save capital gains tax. This bond is a big relief to those people who already has a house and can’t take benefit of section 54. The investment into these bond save the capital gains tax.

Features of Capital Gains Bond

·         These bonds give exemption from capital gains tax.

·         You can put all of your capital gains into these bond. The money invested into these bonds is exempted from the capital gains tax.

·         The capital gains bond give annual interest rate of 6%. It is lower than the prevailing fixed deposit rate.

·         The interest of capital gains bond is taxable but TDS is not applicable.

·         You must invest the capital gains into these bond within 6 month of capital gain realization.

·         The money is invested for 3 years. It remain locked for 3 years.

·         After 3  years, you don’t get any interest. The redemption of capital gains bond has become automatic.

·         You can’t transfer these bonds to anyone.

·         These bonds can’t be pledged or sold

·         If the amount invested in bonds is less than the capital gains realized, only proportionate capital gains would be exempt from tax.

·         The bonds are very secure. These bond are AAA rated by the rating agencies.

·         The face value of the bond is 10,000.

·         Minimum investment should be of Rs 20,000.

·         The investment into the capital gains bond can’t go beyond 50 lakhs in a financial year.

·         Bonds can be held in Demat /Physical Form

·         You can invest in capital gains bond of NHAI and Capital gains bond of REC through the designated branches of the banks. You can download the form NHAI and REC online.

4. Capital Gains Account Scheme

There is another method to save capital gains tax. This scheme is for those people who can’t invest in a new residential property before efiling income tax return. It gives relief to the taxpayer for time being. You can put money in this scheme for 3 year. During this period you can use the capital gains for purchasing or constructing a new residential house. Following are the features of capital gain account scheme.

Features of Capital Gain Account Scheme

·         The deposit should be made before filing income tax return. The investment in capital gain account scheme should be mentioned in the income tax return.

·         The account can be opened only with specified banks. Every scheduled banks open capital gains account. You can open account from any branch. The cooperative bank and regional bank are not eligible for this account.

·         The deposit can be made in lump sum or in instalments at any time on or before the due date for filing the return of income. You sold a property on 15 January 2015, and are not able to use the gains by 31 July 2015. In such a situation, you should open a CGAS account and deposit the money in it by 31 July.

·         You can deposit in cash, by cheque or by draft.

·         There are two types of accounts—account A and account B

·         Account A is  similar to a savings account. You can put or withdraw money as per your requirements. The interest rate of Account A is similar to the saving account. It is 4%.

·         Account B is similar to the fixed deposit. You put money for the specified period. The interest rate of account B is comparable to the fixed deposits.

·         If you plan to buy a property after a year, choose account B. But if you plan to build a house soon, and would need money periodically, choose account A.

·         Money withdrawn has to be used within 2 months.

·         The interest rate is fixed periodically by the Reserve bank of India.

·         You can transfer all of your money from type A account to type B account or vice versa.

·         The amount deposited in capital gains account can’t be used as mortgage for any loan.

·         The interest on capital gains account is taxable.

       The TDS is deducted as per the provisions.

-RCS.
rcs.hrr@gmail.com