How to save capital gains tax while selling a house?
What is capital gains tax?
Capital gains means the profit obtained from the sale of a non inventory asset which had been purchased at a lower price than the sale amount. Capital gains tax is the tax levied on this profit. Capital gains tax may be levied on sale of various assets – bonds, stocks, precious metals and property.
Buying property for investment purpose and selling it off later is a regular practice. However, if you are looking at making profit from selling your ancestral property or selling a house which you had bought earlier, you should keep an eye on the tax payable on the gains.
Capital gains on property
In India, if a property is held for more than 36 months, then the profit obtained form its sale is regarded as long term capital gains. If the property is held for less than 36 months,i.e. 3 years, then the gains made of sale is regarded as short term. While long term capital gains are taxed at a rate of 20%, short term gains are taxed at normal rate.
In case of shot term gains, an individual is taxed as per the tax slab he/she falls under. For example, if he/she falls under 20% tax slab, then 20% tax will be levied on capital gains.
Ways to save capital gains tax:
1. Indexation
In case of long term gains, i.e. the property being sold after 3 years, tax is calculated as per indexation. Indexation involves cost inflation index on the basis of which cost of acquisition of the property is recalculated. As the inflation factor is taken into account, cost of the asset is increased and gains is reduced. Hence the tax payer gets benefitted from indexation.
Indexation rates are notified for every financial year by the government. The indexed cost is calculated as per the following rule:
Indexed cost = original cost x (indexation rate for year of sale/indexation rate for the year of purchase)
Long term capital gains are calculated as: Capital gains = Sale price – Indexed cost
Indexation is included in determining profit in case of long term capital gains. As the tax payer is able to inflate the cost of his/her assets, it is advisable to hold the asset for more than 3 years, so that you can lessen the tax as compared to short term gains.
2. Investment in real estate
You can claim tax exemption under Section 54 on the long-term capital gain on sale of a property. If you buy a house within two years or construct a house within three years with all the profit made of sale, then you can avail tax exemption.
You can avail tax exemption if you had bought a second house within a year before selling the first house.
Further, you can avail tax exemption under Section 54 (F), too. For this, you need to own not more than one house and invest sale proceeds from assets other than a house in real estate. Real estate investment in India must be made in residential properties, not in commercial properties or vacant plot, in order to avail tax exemption.
3. Investment in capital gain bonds
You can avail tax exemption on sale of a house if the profit is invested in either bonds of the National Highways Authority of India and Rural Electrification Corporation Limited for three years. The investment has to take place within six months of realising the profit, i.e. selling the house. However, investment is allowed only up to Rs 50 lakh in a financial year. Usually the interest on these bonds is around 5-5.5%.
Hence, few factors should always be kept in mind when you are going to buy or sell a property. While making profit by selling a house, you need to know which tax bracket you fall under when calculating capital gains tax and also whether or not indexation can save tax payable for you.
