Capital gain is the profit that one earns from selling of capital assets, such as stocks, bonds, or real estate. This gain occurs when the selling price of the asset is higher than its purchase price. In other words, it’s the positive difference between the selling price (which is higher) and the cost price (which is lower) of the asset. Conversely, a capital loss occurs when the cost price of the asset is higher than the selling price. In this situation, the seller incurs a loss, as the selling price is lower than what they initially paid for the asset. When it comes to land sale, whether or not it becomes a capital gain depends on certain conditions given below:
(i) Rural Agricultural Land: Rural agricultural land is not considered a capital asset. Therefore, no capital gains tax is applicable when you sell such land. In other words, if you sell land located in a rural area primarily used for agricultural purposes, you won’t incur capital gains tax.
(ii) Urban Agricultural Land: On the other hand, urban agricultural lands are considered capital assets. This means that if you sell land located in urban areas and it has been used for agricultural purposes, capital gains tax will be applicable on the profit earned from the sale.
(iii) Agricultural Use Requirement: To determine if a piece of land qualifies as agricultural land for this purpose, it must have been used for agricultural activities for a minimum of 2 years before its sale. This condition ensures that the land has genuinely been utilized for farming or agricultural purposes and not merely for speculative or non-agricultural purposes.
In summary, whether the sale of land attracts capital gains tax depends on the location (rural or urban) and its use for agricultural purposes for at least 2 years prior to the sale. Rural agricultural land generally does not incur capital gains tax, while urban agricultural land does, provided it meets the specified criteria.
Types of Capital Gain
There are two main types of capital gains based on the holding period of the asset:
(i) Short-Term Capital Gain: This type of capital gain occurs when you sell a capital asset, such as land, before holding it for a period of 24 months. In other words, if you sell the land within 24 months of acquiring it, any profit from the sale will be categorized as a short-term capital gain. Short-term capital gains are typically subject to different tax rates than long-term capital gains and are often taxed at the individual’s applicable income tax rate.
(ii) Long-Term Capital Gain: On the other hand, a long-term capital gain arises when you sell a capital asset like land after holding it for a period of 24 months or more. In some cases, for movable properties, the holding period required for it to be considered a long-term capital gain is extended to 36 months. Long-term capital gains generally benefit from favorable tax rates, which are typically lower than the tax rates for short-term capital gains.
Calculation of Capital Gain
The calculation of capital gain is based on a formula that takes into account various factors, including the sale proceeds, the cost of acquisition, the cost of improvement, the cost of sale and Indexation. Here’s how the formula works:
(i) Capital Gain = Sale Proceeds – Cost of Acquisition – Cost of Improvement – Cost of Sale
(ii) Sale Proceeds: This is the total amount you receive from selling the capital asset, in this case, land.
(iii) Cost of Acquisition: This represents the original cost at which you acquired the land. It includes the purchase price and any other expenses directly related to the acquisition, such as legal fees, brokerage charges, and stamp duty. In the case of ancestral property, the cost of acquisition incurred by the donor (the person who passed down the property) may be considered for indexation.
(iv) Cost of Improvement: If you’ve made any improvements to the land that have increased its value, these costs are factored in. Improvements might include expenses for renovations, construction, or any other enhancements that have been made to the property.
(v) Cost of Sale: This includes the expenses incurred during the sale of the property, such as brokerage fees, legal fees, and other transaction costs directly related to the sale.
For Long-Term Capital Gains (LTCG), there’s an additional factor “Indexation” to consider:
(vi) Indexation: When calculating LTCG, the Cost of Acquisition and Cost of Improvement are indexed using the Cost Inflation Index (CII). Indexation takes into account inflation over the holding period to adjust the original purchase and improvement costs for inflationary changes in the economy. This helps in reducing the tax liability on LTCG by accounting for the decrease in the real value of money over time.
The indexed Cost of Acquisition and Cost of Improvement are subtracted from the Sale Proceeds along with the Cost of Sale to calculate the LTCG. This adjusted LTCG is then subject to the applicable tax rate for long-term capital gains in your tax jurisdiction.
Tax Rate for Capital Gains
The tax rates for capital gains depend on whether they are short-term or long-term:
(i) Tax Rate on Short-Term Capital Gain (STCG): Short-term capital gains are taxed at the individual’s applicable income tax slab rate. This means that the tax rate you pay on your short-term capital gains is the same rate at which you pay your regular income tax. Short-term capital gains are typically subject to the standard income tax rates applicable to your total taxable income for the financial year.
(ii) Tax rate on Long-Term Capital Gain (LTCG): Long-term capital gains are subject to a specific tax rate, which is set at 20% of the capital gain amount. This fixed tax rate applies to long-term capital gains on various assets, including land, stocks, and other investments.
Exemptions From Capital Gain on Sale of Land
(I) Exemption under section 54F:
Under Section 54F of the Income Tax Act, an assessee can avail of full exemption from capital gains tax if they meet certain conditions and invest the entire sale proceeds from the sale of a capital asset (land) in purchasing or constructing a new residential property. Here are the key conditions that need to be satisfied for this exemption:
(i) Purchase of New House: The taxpayer must buy a new house either within 1 year before the sale of the land or within 2 years after the sale of the land.
(ii) Construction of New House: Alternatively, the taxpayer can construct a new house within 3 years from the date of sale of the land.
(iii) Hold Period: The taxpayer must not sell the newly purchased or constructed house within 3 years from the date of its purchase or construction.
(iv) Location: The new house property must be situated within India.
(v) Ownership of Other Houses: The taxpayer should not own more than one house property (other than the new one) on the date of the sale of the land. In other words, the taxpayer should not have more than one residential property other than the one they are claiming a deduction for.
(vi) Restrictions on Further Purchase/Construction: The taxpayer cannot purchase another residential house within 2 years of the sale of the land or construct another residential house within 3 years of the sale of the land, except for the one for which the deduction is being claimed.
(vii) Partial Investment: If the entire sale proceeds are not invested in purchasing or constructing the new house, the capital gain tax exemption will be available in proportion to the amount of investment made. In other words, the exemption will be partial if only a portion of the sale proceeds is reinvested.
(viii) Capital Gain Account Scheme: If the taxpayer is unable to invest the entire sale amount until the date of filing the income tax return (typically by July 31), they can still claim the deduction by depositing the uninvested amount in a Public Sector Undertaking (PSU) bank or any other bank under the “Capital Gain Account Scheme 1988.” However, they must invest this amount within the stipulated period, which is 2 years for purchase and 3 years for construction.
Meeting these conditions allows the taxpayer to claim a full or partial exemption from capital gains tax on the sale of a capital asset when the sale proceeds are reinvested in a new residential property in accordance with Section 54F of the Income Tax Act. It’s important to carefully follow these conditions and maintain proper documentation to claim the exemption accurately.
(II) Exemption under section 54 EC:
Section 54EC of the Income Tax Act provides a deduction option for individuals who do not wish to invest in a new house property but still want to avail of tax benefits on their capital gains. Under this section, an assessee can claim a deduction if they invest the entire sale proceeds from the sale of a capital asset (such as land) in specified bonds within a specified time frame. Here are the key details related to this deduction:
(i) Investment in Specified Bonds: The taxpayer can avail of this deduction by investing the entire sale proceeds in bonds that are specified for this purpose. The specified bonds are typically issued by government entities like the National Highways Authority of India (NHAI) and the Rural Electrification Corporation (REC).
(ii) Time Limit for Investment: The taxpayer must make this investment within a period of 6 months from the date of sale of the capital asset or before the due date of filing their income tax return, whichever comes earlier.
(iii) Lock-In Period: The specified bonds typically have a lock-in period of 5 years. This means that the taxpayer cannot redeem or sell these bonds before the completion of 5 years from the date of their purchase.
(iv) Maximum Investment Amount: The maximum amount that can be invested in these specified bonds to claim this deduction is limited to 50 lakhs (50,00,000 INR).
Conclusion
In summary, both Section 54F and Section 54EC offer valuable avenues for taxpayers to reduce their tax liability when selling land or other assets. But it is important for taxpayers to adhere to the specific conditions and timelines outlined in these sections to avail of the tax benefits successfully. Additionally, it is essential to keep detailed records of all these financial transactions and expenses to accurately calculate your capital gains and comply with tax regulations. Tax laws and regulations may vary from time to time, so it’s advisable to consult with a tax professional or refer to the current tax laws in your jurisdiction for precise calculations and guidance.
For more details on long-term capital gain tax, please follow the link of Income Tax Department-https://incometaxindia.gov.in/tutorials/15-%20ltcg.pdf
To know the calculation of long-term capital gain on sale of land, please go through the video in this link-https://www.youtube.com/watch?v=PJtKu0TLz2s
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