How to save tax on property - For sellers

When selling a property, understanding the tax implications is crucial for maximizing your returns. This article provides a comprehensive guide to capital gains tax for property sellers, focusing on how to minimize or even eliminate your tax burden.

Understanding Capital Assets

Capital assets encompass various items, including land, buildings, jewelry, vehicles, trademarks, machinery, patents, and licenses. Profit realized from the sale of a capital asset is known as capital gains. It's important to note that agricultural land is specifically excluded from the definition of a capital asset.

Capital Gains Tax on Residential Property

Capital gains tax on residential properties is categorized into two types: long-term and short-term. Let's explore each of these:

1. Long-Term Capital Gains (LTCG): If you own a property for more than 24 months, any profit you make from its sale is considered a long-term capital gain and is taxed at a flat rate of 20%. However, certain exemptions are available, which we will discuss later.
2. Short-Term Capital Gains (STCG): If you own a property for less than 24 months, the profit is classified as a short-term capital gain. STCG is taxed at your applicable income tax slab rate. For example, if you fall within the 30% tax bracket, your STCG tax will also be 30%. Unlike LTCG, STCG does not offer any indexation benefits (adjustments for inflation). Simply put, the difference between your purchase price and the selling price will be the amount that is eventually be taxed.

Here’s a table summarizing the key differences between LTCG and STCG:

Capital Gains Tax Exemptions

Now, let's delve into three key provisions that can help you save on long-term capital gains tax when selling residential property or other assets:

1. Section 54: This section provides tax benefits to individuals and Hindu Undivided Families (HUFs) who have owned a residential property for a minimum of two years. Crucially, only constructed residential properties are eligible; vacant plots do not qualify. If you reinvest the profits from the sale into purchasing one or two new residential properties, or constructing a new one, you can completely avoid paying LTCG tax. The reinvestment can be made within one year before or two years after the sale, or within three years for construction. You only need to reinvest the profit amount, not the entire sale proceeds.
   • For instance, if you bought a property for ₹60 lakhs and sold it for ₹90 lakhs, your LTCG would be ₹30 lakhs. Reinvesting this ₹30 lakhs makes you eligible for a full exemption. The maximum claimable exemption under this section is ₹2 crores, usable only once in a lifetime. This exemption, however, gets reversed if you sell the new property within three years of purchase. To avail of this benefit, the funds must be parked in a designated capital gains account, not a regular savings account.
2. Section 54EC: This provision allows individuals to invest the capital gains from the sale of any asset (stocks, mutual funds, bonds, house property, etc.) into specified bonds. These bonds require a three-year holding period and must be purchased within six months of the asset sale. You can invest up to ₹50 lakhs in these bonds, which offer attractive returns and come with a 5-year lock-in period.
3. Section 54F: Similar to Section 54, this section allows individuals and HUFs to claim exemptions on capital gains from assets other than a house property (e.g., stocks, bonds, commercial property, plots). However, the claimant must not own more than one residential property. Reinvestment must be made into purchasing or constructing a residential property (not a plot) within the specified timelines as section 54. Unlike Section 54, Section 54F requires reinvestment of the entire sale proceeds to claim a full exemption, not just the profit portion. Selling the new property within three years reverses the exemption. Reinvestment needs to happen in a Capital gain account not savings account to claim the exemption.