Ajay is planning to sell his old flat in Punjab and wants to buy a new one in Mumbai. He purchased this flat in March 2014. Ajay is confused regarding the Capital Gains Tax on sale of property, because his friend was telling him that the entire profit on sale will be taxable as per his Income Tax slab of 30%. Let us analyse the tax implications on such property transactions.
What is Capital Gains Tax on Sale of Property ?
Your tax liability on the sale of property will be decided based on the number of years of holding. If you are selling the property after 2 years of holding, the gains will be treated as long-term capital gain. But if you are selling it within 2 years of holding it, the gains will be treated as short-term capital gain.
The short-term capital gain will be added to your income in the year of sale and will be taxed as per your tax slab. If you are selling a property within 2 years of holding and if you receive a profit of 5 lakhs in the transaction, this amount of 5 lakhs will be added to your other income of that year and will be taxed as per your tax slab. If you are in the 30% slab, you will end up paying 30% of 5 Lakhs as short-term capital gains tax on sale of property.
But long-term capital gains will be taxed at a lower rate of 20%. Here, you will get the benefit of indexation also. Indexation will help you in reducing your tax liability.
How are capital gains taxed?
With effect from Financial Year 2017-18, the base year for calculation of Indexation is 2001. If you have bought the property before 2001, you can either use the previous cost indexation chart or check the fair market value of the property in 2001
Indexation is a process which allows you to recalculate your cost of purchase according to the cost of inflation index published by RBI every year. Indexation will help you to increase the purchase cost to offset for the inflation.
Suppose, you have purchased a flat in 2003-04 for Rs. 5 Lakhs and sold it in 2013-14 for Rs. 25 Lakhs. You got a profit of Rs. 20 Lakhs. How to calculate the Capital Gains Tax on sale of property?
The cost of inflation index for 2003-04 is 109 and that for 2013-14 is 220.
The indexed cost of the flat at the time of sale will be 5,00,000 x 220/109 = 10,09,174.
Long-term Capital Gains = Sale price – Indexed cost of purchase
Long-term Capital Gains in this case will be 25,00,000 – 10,09,174 = 14,50,739.
So, your Long-term Capital Gains Tax on sale of property will be 20% of this gain of 14,90,826. This works out to 2,98,165.
Long Term Capital Gain Tax Rate for 2020-21
Here is the Long Term Capital Gain Tax Rate for 2020-21
Also Read : Cost Inflation Index Calculations for 2020-2021
Capital Gain on sale of house property Section 54
As per Section 54 of the Income Tax Act, if you invest the Long-term Capital Gains in a new residential property, such gains are exempted from paying tax. But you have to make such investment in a new property either one year before or within 2 years from the sale of your property. You can also construct a new house within 3 years from the date of sale.
Can you avoid capital gains tax if you reinvest?
But, if you have not finalized a new property and invested the gains before the due date of filing your IT returns, you have to deposit such gains in a special account called Capital Gain Account Scheme. This is to show your intention to buy a new property to avoid Capital Gains Tax. You can withdraw the amount from this account as and when you finalize the property.
In case the amount deposited is not used for the purchase or construction of a new house within the period specified, the unused amount will be treated as income of the previous year, in which the period of three years from the date of the transfer of the original house expires.
You have to hold the new property for at least 3 years. If you are selling it before 3 years, the Short-term Capital Gains on that sale and the amount of capital gains exempted earlier also will be added to the income in the year of sale of the new property and taxed as per your tax slab of that year.
Can I save Long-term Capital Gains Tax on sale of property without buying another property?
Yes. In this case, you have to invest the Long-term Capital Gains in specific financial instruments. Such bonds are issued by National Highways Authority of India (NHAI) and Rural Electrification Corporation (REC). Such bonds are offering 5% returns now. The investment in such bonds for tax benefit is limited to Rs. 50 Lakhs per year under Section 54EC of the IT Act. You can withdraw the amount after 5 years.
How can I avoid capital gains tax on property?
Ajay is much relieved now because his gain will be long-term in nature. Long-term Capital Gains Tax on sale of property can be avoided by investing the gains in a new property at Mumbai. But he should not sell his new flat in Mumbai for the next 3 years.