7 Best Ways to Save Capital Gains Tax

What is Capital Gains Tax on Property?

Capital gains are the profit you make when you sell a capital asset – a plot of land, a residential house, a commercial building, or any other capital asset for a higher price than the price you paid for acquiring it. The rates levied are 20% for Long Term Capital Gains (LTCG) and Short Term Capital Gains (STCG), depending on an individual’s property tax bracket. Capital gains can be divided into two major classifications:

Short Term Capital Gains Tax on Property

STCG tax on property is the capital gains arising out of the sale of any property within 24 months from the date of purchase of the said property. For the given financial year in India, STCG is included in the seller’s total income and is charged to the seller according to the income tax rates applicable to his tax slab. Knowledge of STCG is important as it provides important insights on how best to deal with tax issues.

Long Term Capital Gains Tax on Property

LTCG tax on the property is levied on the capital appreciation gained from the sale of a property, provided that the property was held for 24 months and above. In India, long term capital gains on property are further taxed at 20% with an indexation advantage, meaning that the property benefits from the inflation rate at the time of sale. An understanding of LTCG is important as it should form part of the tax planning process alongside directing individuals in managing their real estate investment.

Capital Gains Tax Exemptions on Selling Property

An individual can choose from four tax exemptions (sections 54, 54B, 54F, and 54EC) based on the type of reinvestment made after receiving long-term capital gain consideration.

How to Calculate Capital Gains Taxes?

To calculate capital gains taxes, subtract the original purchase price of an asset from the selling price to determine the gain. Then, the relevant tax rate based on how long the asset was held (short-term or long-term) will be applied to the gain.

Calculation of Short Term Capital Gains Tax

For short term capital gains, here’s the formula to use:

Short-term capital gains = Total sale price of the property – (cost of initial purchase + expenses incurred during the sale + cost of renovations made (if any).

This amount should be added to your taxable income.

Calculation of Long Term Capital Gains Tax

The formula for long-term capital assets is similar; however, the difference is that the “Indexed Cost of Improvement/Indexed Cost of Acquisition” is from the sale price.

You should apply the cost inflation index (CII) to arrive at the indexation. Indexation helps you adjust the purchase price to account for the inflation rate for the years you have held the property. This increases your cost base and lowers capital gains on par with the inflation rates.

What is the procedure to file capital gains tax in India?

Once you have calculated your capital gains and the type, the next step is to include it in your income tax returns. You have to disclose details like cost of purchase, type of asset, sales consideration, transfer expenses, etc., in your income tax details.

Now that you’ve understood the basics of what capital gains tax is and how to calculate and file it let’s take a look at how to avoid capital gains tax in India while selling a property.

How to Avoid Capital Gains Tax- 7 Secrets Revealed 

Generally, the capital gains tax you have to pay when selling a property runs in lakhs. However, you can substantially reduce it by using one of the following methods:

1. Exemptions under Section 54F, when you buy or construct a Residential Property

Very often, when people move to a new house, they sell their old house to pay for the new house. In such cases, if you use the sale proceeds obtained from selling your old property to pay for the new one, you are exempted from capital  gains tax under Section 54F if you meet the following conditions:

• You buy a new house one year before the selling of the old house.

• You buy a new house up till two years after the sale of the old house, or you construct a new house up till three years after selling the old house.

• You cannot sell the new house for the next three years; otherwise, the exemptions are withdrawn. Here, the three years are calculated from the date of acquisition or completion of the new house.

Currently, Section 54F applies to only one residential property. It allows for the sale of non-residential property to purchase a residential property. If you use all of the capital gains to purchase the new property, then you don’t have to pay any capital gains tax.

Who is it for? Exemptions under Section 54F are ideal for people who sell a property to pay for the purchase of a new residential property.

2. Purchase Capital Gains Bonds under Section 54EC

If you are selling a property but have no interest in purchasing a residential property using the proceeds, then you can make use of capital gains bonds.

Let’s take a look at the features of capital gains bonds:

• Capital gains invested in these bonds are exempt from the capital gains tax. If you invest the entire amount you get by selling a property, then you don’t have to pay any capital gains tax.

• These bonds give an annual interest of 5-6%, which is lower than the rates of fixed deposits.

• You must invest the sum within six months of selling the property.

• It has a lock-in period of five years. At the end of five years, the redemption of these bonds is automatic.

• These bonds cannot be sold or transferred to anyone.

• Capital gains bonds are highly secure and have an AAA rating.

• The minimum investment is Rs. 10,000, and the face value of each bond is Rs. 10,000.

• You cannot invest more than Rs 50 lakhs in capital gains.

• You can hold the bonds either in physical or demat form.

• These bonds are sold through banks, and you can choose from NHAI or REC bonds.

Who is it for? Capital gains bonds work well for people not interested in purchasing a new residential property.

3. Investing in Capital Gains Accounts Scheme

Purchasing a new residential property may take time. You have to find a preferred home/apartment that you like to buy, negotiate with the seller, and complete paperwork – all of which can be time-consuming.

Investing in capital gains accounts gives you temporary relief. Consider this as parking your capital gains tax safely for the time being while you scout for a new property. You can invest the capital gains you obtained by selling a property in a public sector bank or other banks approved by the Capital Gains Account scheme of 1988.

4. Invest for the long term

If you manage to find great companies and hold their stock for the long term, you will pay the lowest rate of capital gains tax. Of course, this is easier said than done. A company’s fortunes can change over the years, and there are many reasons you might want or need to sell earlier than you originally anticipated.

If you want to learn about GST on flat purchases, here is a comprehensive guide on the subject.

5. Take advantage of tax-deferred retirement plans

When you invest your money through a retirement plan, such as a 401(k), 403(b), or IRA, it will grow without being subject to immediate taxes. You can also buy and sell investments within your retirement account without triggering capital gains tax.

In the case of traditional retirement accounts, your gains will be taxed as ordinary income when you withdraw money, but by then, you may be in a lower tax bracket than when you were working. With Roth IRA accounts, however, the money you withdraw will be tax-free as long as you follow the relevant rules.

For investments outside of these accounts, it might behove investors who are near retirement to wait until they stop working to sell. If their retirement income is low enough, their capital gains tax bill might be reduced, or they may be able to avoid paying any capital gains tax. But if they’re already in one of the “no-pay” brackets, there’s a key factor to keep in mind: If the capital gain is large enough, it could increase their taxable income to a level where they’d incur a tax bill on their gains.

You can use capital losses to offset your capital gains as well as a portion of your regular income. Any amount that’s left over after that can be carried over to future years.

6. Use capital losses to offset gains

If you experience an investment loss, you can take advantage of it by decreasing the tax on your gains on other investments. Say you own two stocks, one of which is worth 10% more than you paid for it, while the other is worth 5% less. If you sold both stocks, the loss on the one would reduce the capital gains tax you’d owe on the other. Obviously, in an ideal situation, all of your investments would be appreciated, but losses do happen, and this is one way to get some benefit from them.

If you have a capital loss that’s greater than your capital gain, you can use up to $3,000 of it to offset ordinary income for the year. After that, you can carry over the loss to future tax years until it is exhausted.

7. Pick your cost basis

When you’ve acquired shares in the same company or mutual fund at different times and at different prices, you’ll need to determine the cost basis for the shares you sell. Although investors typically use the first in, first out (FIFO) method to calculate cost basis, there are four other methods available: last in, first out (LIFO), dollar value LIFO, average cost (only for mutual fund shares), and specific share identification.

In your income tax returns, you can claim tax exemptions for the money you have parked in capital gains accounts in approved banks. You don’t have to pay any tax for it. However, the amount has to remain with the bank for three years; failing, the deposit will be treated as capital gains, and you will have to pay tax for it in the next financial cycle.

Who is it for? Investing in a capital gains account scheme is ideal for people who want to purchase a residential property by using the proceeds but want a place to park it temporarily, till they complete the details of the purchase.

While looking for ways to save on taxes, understanding the impact of GST is also crucial. View our blog on Current GST on Flat Purchase (2024)—A Complete Guide for Home Buyers to learn more about GST and taxes on flat purchases.

Example of Capital Gains Tax while Selling Property in India

Say Mr Amit purchased a house in 2001-02 for INR 10,00,000. He happily lived in the house with his family and children. His children have grown up and are well-settled in the USA. Hence, In 2018, he plans to sell his current property for Rs. 40,00,000 and use its proceeds to buy a new home at a purchase price of Rs. 40,00,000.

The long-term capital gain for Amit in this situation is calculated below.:

The capital gains tax he will save on the deal of selling his property in India is calculated as below:

Hence, if the purchase value of the new house is more than the long-term capital gain, the tax payable will be nil in this case. Capital gains tax is one of the unavoidable side effects of selling property in India. However, you can avoid paying large sums as capital gains tax by using any one of the above methods listed here. Understand the different exemptions available to you and pick the right one that suits your specific situation.

Conclusion

Capital gains tax on the sale of properties has certain intricacies; however, proper measures can be employed to either minimise or completely shift the burden of this tax. You can save money by availing different tax exemptions such as Sections 54, 54EC, and 54F, investing in capital gains bonds, or redepositing gains in a capital gains account scheme. Also, long-term investment and an effective utilisation of capital losses can even decrease the income tax. Knowledge of these methods can assist you in controlling your real estate investments much better, enabling you to retain more of your profit. However, everyone should consult a tax consultant to decide on the most suitable option, depending on his conditions.