Introduction
Capital gains refer to the profit earned from the sale of a capital asset, such as stocks, bonds, or real estate. In simple terms, if the selling price of the asset is higher than its purchase cost, the difference is considered a capital gain. Conversely, if the purchase cost is higher than the selling price, it results in a capital loss. However, there are cases where adjustments and additions need to be made to the purchase cost in order to determine the true value of the capital gain. We will explore these adjustments later in this article. In this article, our focus will be on the income tax regulations related to capital gains from the sale of residential property.
Types of Capital Gain
(i) Short-Term Capital Gain: This type of capital gain occurs when you sell a capital asset, such as a residential house, before holding it for a period of 24 months. In simpler terms, if you sell the house within 24 months of acquiring it, any profit from the sale will be classified as short-term capital gain. Short-term capital gains are usually subject to different tax rates compared to long-term capital gains. They are 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 a residential house after holding it for a period of 24 months or more. In some cases, especially 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 typically enjoy more favorable tax rates, which are generally lower than the tax rates applied to short-term capital gains.
Computation of Capital Gain on Sale of Residential Property
The computation of capital gain on the sale of a residential house involves several factors and can be calculated using the following formula:
Capital Gain = Sale Proceeds – Cost of Acquisition – Cost of Improvement – Cost of Sale
Here’s a breakdown of the components involved:
(i) Sale Proceeds: This is the total amount you receive from selling the residential property.
(ii) Cost of Acquisition: This represents the original cost at which you acquired the house property. 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.
(iii) Cost of Improvement: If you’ve made any improvements to the house 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.
(iv) 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 of the house.
For Long-Term Capital Gains, there’s an additional factor called “Indexation” to consider:
(v) Indexation: When calculating Long-Term Capital Gain on sale of house property, 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 Long-Term Capital Gains 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 Long-Term Capital Gain. This adjusted Long-Term Capital Gain is then subject to the applicable tax rate for long-term capital gains.
Rates of Tax on Capital Gain
The tax rates for capital gains are determined by whether they are classified as short-term or long-term:
(i) Tax Rate for 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 for 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 that apply to your total taxable income for the financial year.
(ii) Tax Rate for Long-Term Capital Gain (LTCG): Long-term capital gains are subject to a specific tax rate, which is fixed at 20% of the capital gain amount. This uniform tax rate applies to long-term capital gains from various assets, including residential houses, land, stocks, and other investments.
Exemption Under Section 54 of Income Tax Act
Under Section 54 of the Income Tax Act, there is a provision for granting an exemption to taxpayers, specifically individuals and Hindu Undivided Families (HUFs). This exemption applies when a taxpayer sells their residential house, which is considered a Long-Term Capital Asset (LTCA), and utilizes the capital gain from the sale to acquire another residential house. A Long-Term Capital Asset, as per the Income Tax Act, is a property that has been held for a period exceeding 24 months.
This exemption is designed to provide relief to individuals and HUFs who are not selling their residential property to earn income but rather to secure a new suitable residential property for their own use. By granting this exemption, the tax authorities aim to ensure that such property transactions are treated fairly and genuinely, without imposing income tax on the sale when the primary intent is to acquire a new residence.
Conditions & Restrictions to satisfy for availing the exemption under Section 54
To avail the exemption under Section 54 of the Income Tax Act when selling a residential house and acquiring another one, taxpayers must satisfy several conditions and restrictions:
(a) The new house must be purchased within one year before or two years after the sale of the old house, or it should be constructed within three years after the sale of the old house. In cases of compulsory acquisition, the period for acquisition or construction is determined from the date of receipt of compensation, whether it’s the original compensation or additional compensation.
(b) Starting from the Assessment Year 2024-25, there is a limitation on the maximum exemption allowable under Section 54. If the cost of the new residential asset exceeds Rs. 10 crores, the excess amount will not be considered when calculating the exemption under Section 54.
(c) From the Financial Year 2021-22 onwards, taxpayers can avail the exemption on the purchase or construction of a maximum of two residential houses by utilizing the capital gain, provided that the gain from the sale of the old house does not exceed Rs. 2 crores. Once this option is exercised, it cannot be used again for the same or any further assessment year.
(d) If a taxpayer uses the capital gain amount to purchase a plot of land and construct a residential house on it, both the money spent on purchasing the land and the cost of constructing the residential house will be considered as an investment in residential property for the purpose of claiming the exemption under this section.
(e) The exemption under Section 54 will be the lower of (i) the amount of capital gains arising from the sale of the residential house and (ii) the amount invested in the purchase or construction of the new residential house, including the amount deposited in the Capital Gains Deposit Account.
(f) If a taxpayer is unable to utilize a part or the full amount of the capital gain until the due date of filing the Income Tax Return (ITR) for the year in which the old house is sold, he must deposit the unspent amount in a Capital Gains Deposit Account in any public sector bank, following the Capital Gains Deposit Account Scheme of 1988. The new house can then be purchased or constructed by withdrawing the amount from this account within the specified time limits of two or three years, respectively. Otherwise, capital gains tax will be levied on the unspent amount of capital gain.
(g) If a taxpayer purchases or constructs a new house, claims exemption under Section 54, and transfers the new house within three years from the date of its acquisition or completion of construction, the benefit granted under Section 54 will be withdrawn. This is done by deducting the exempted capital gain from the cost of acquisition of this house when computing capital gain on the sale of the house.
(h) Exemption under this section can only be claimed for house properties purchased or constructed in India.
(i) Tax on short-term capital gains (property held for less than 24 months) is calculated based on the individual’s income tax slab rates, and basic exemptions are allowed accordingly.
Conclusion
In conclusion, Section 54 of the Income Tax Act serves as an incentive for investment in residential properties by offering an exemption on capital gains. Taxpayers must carefully follow the stipulated conditions and timelines to take full advantage of this tax benefit. A clear understanding of the provisions outlined in this section can empower individuals and Hindu Undivided Families (HUFs) to make informed choices when selling and acquiring residential properties while avoiding potential disputes with the income tax authorities.
For more details about Exemption u/s.54 with help of examples, please go through this Link of Income Tax Department–https://incometaxindia.gov.in/tutorials/16.%20exemption%20under%2054.pdf
For a better understanding of this topic, please watch the video from ICAI–https://www.youtube.com/watch?v=B54VER12PkU
You may also Like–https://anptaxcorp.com/capital-gain-on-sale-of-land/
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