Property investments have gained currency these days. In the past five years or so, property values have shot through the roof. There are many who are hence investing in property these days.
Property is sold either to buy another property – probably a bigger residence or a better locality or both. It may also be to simply book a profit, when the valuations have become attractive.
Vikram was doing the latter. He was getting transferred out on Mumbai, to his hometown – Delhi. He had bought his residential property in a Mumbai suburb, about 6 years back. Now, he is interested in selling it as he plans to settle down in Delhi and he even has a buyer for it. He is seriously considering that, but wanted to know a bit about the tax matters surrounding sale of property. He wanted to know his options.
When a property is sold and the profits are retained, taxes have to be paid. In property transactions, normal income tax does not apply; capital gains taxes apply. For properties sold after 3 years of acquisition, Longterm Capital Gains ( LTCG ) applies. Short term capital gains apply for properties sold less than 36 months after it is bought. Short term capital gains are at the applicable tax rates for an individual. Longterm capital gains are 20% after applying the cost inflation index. Cost inflation index is applied to compensate for the effect of inflation, over time.
He has the option of paying the tax computed after indexation @ 20% and invest in a good instrument and earn good returns. If he invests in Equity Mutual Fund Schemes for instance, he will be able to get good double digit, tax free returns. This is a good option too, as one need not invest in low-yielding propositions, for the sake of saving tax or be forced to invest in another property. But then many people want to save taxes at all costs.
If Vikram does not want to pay tax, he also can invest the gains in Capital Gain bonds ( under Sec 54EC ). These bonds are issued by entities like Rural Electrification Corporation ( REC ), National Housing Boad ( NHB) etc. There is a six month window in which to purchase these bonds. Currently, they yield about 6% and have a lockin period of 3 years. The problem in this case is that though Vikram would be able to save tax by investing in these bonds, he is also potentially losing, as the interest rate on these bonds are low. The income from these bonds are however taxable. Also, the maximum one can invest in a capital gain bond is Rs.50 Lakhs for a Financial year. However, if the transaction has happened after 1st October of the year, then the window flows to the next financial year too allowing one to invest upto Rs.1 Crore.
Vikram has another way of saving tax too. He can buy another property for the value of capital gains. This comes under Section 54 of IT Act. When buying such a property, it can be bought one year prior to the sale or within two years after the sale. In case of construction of property, the time allowed is three years from the date of sale. The capital gains need to be deposited in a Capital Gains Depost Account before the date for filing returns. Any unutlised amount of this capital gain after the stipulated period, will be charged to income tax in the “previous year” at the end of the three year period. So, part utilization is possible too.
Vikram also wants to know if he can sell in Mumbai and buy in Delhi. It is permitted to buy anywhere in the country. There is a bit of ambiguity on whether one can invest the proceeds on one residential property or more than one. From a strict reading of the clauses, it is safe to assume that the proceeds need to be invested in a single residential property.
Now Vikram’s friend Gaurav has another problem. He has sold a commercial property and would like to save on Capital Gains tax. This is possible too under Section 54F of the IT Act. This is applicable for Capital assets, other than a residential property.
There is one major difference as compared to the sale of residential property and the capital gains treatment there on. Here, Gaurav will have to invest the entire proceeds from the sale into a residential property. The time frames for investment remain the same as in the case of sale of residential property. This however will work if he does not own more than one residential house on the date of transfer of the original asset, excluding the one he would purchase to save capital gains tax.
It is now upto Vikram to make up his mind whether he wants to buy a property or pay the tax and invest elsewhere. He has his options open now.
Published in Business Standard on 5/9/2010
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