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How to save / avoid Long Term Capital Gain (LTCG) Tax on Sale of a House

So, you’ve sold your house and have earned a hefty amount in profit. But you don’t want to pay any income tax on this profit! Is there any legitimate way to do this? Yes, there are more than one ways!

This article explains how income tax can be totally avoided (of course, totally legally!) on long term capital gain (LTCG) earned from the sale of a house.

In the previous two articles on the series on capital gains, we saw:

1. “Long Term and Short Term Capital Gain – Income Tax Calculation“: Difference between long term and short term capital gain, and its taxation

2. “Long Term Capital Gains (LTCG) on Sale of a House – Calculation and Income Tax“: Step-by-step calculation of long term capital gain on sale of a house. (The article also has a table of cost inflation index numbers from FY 1980-81 to FY 2007-08)

Now, let’s see how long term capital gain earned from the sale of a house (a flat or an apartment or an independent house – any residential property) can be avoided altogether!

(Note: There is no way to save income tax on the short term capital gain earned from the sale of a house. This article deals specifically with long term capital gain)

There are two ways to save the income tax on the long term capital gain earned from the sale of a house. Let’s understand each in detail.

 

1. Invest in Bonds – Section 54EC (Sec 54EC of the Income Tax (IT) Act, 1961)

You can save the income tax on the LTCG from the sale of a house, if the long term capital gain is invested in specified bonds.

These include bonds issued by the National Highways Authority of India (NHAI), the Rural Electrification Corporation (REC), Small Industries Development Bank of India (SIDBI), National Housing Bank (NHB) or National Bank of Agricultural and Rural Development (NABARD).

(Also read “Should you invest in Sec 54EC LTCG tax saving bonds?“)

 

How Much is Exempt

The amount of LTCG exempt from income tax is equal to the amount invested in these bonds.

Thus, if you invest the entire LTCG in these bonds, the full amount would be exempt from income tax.

Please note that here, you have to consider the amount of the long term capital gain, and not the entire sale proceeds.

For example, you sell your house for Rs. 15 Lakhs, and your long term capital gain from this sale is Rs. 10 Lakhs.

Now, if you invest Rs. 10 Lakhs in these bonds, you would not pay any income tax on this gain!

(You don’t have to invest the full sale proceed of Rs. 15 Lakhs – you just need to invest the LTCG)

Instead, if you invest, say, Rs. 6 Lakhs in these bonds, you would have to pay a long term capital gains tax on the remaining LTCG of Rs. 4 Lakhs.

Thus, you would pay 20% of Rs. 4 Lakhs = Rs. 80,000 as long term capital gains tax.

 

When to Invest

The investment in these bonds has to be made within 6 months of the sale of the house in order to claim exemption (or relief) under section 54EC.

 

Availability of Bonds

Please note that the availability of these bonds might be limited, as each of these agencies has a cap on the amount of bonds it can issue.

Therefore, please check the availability of these bonds, and plan your sale accordingly if you are planning to take advantage of Sec 54EC.

 

Interest Rate of Capital Gains Bonds

The interest rate on these bonds varies from one agency to another, and changes from time to time.

For example, the 54EC Capital Gains Tax Exemption Bonds Series-VIII issued by the REC (starting 28th May 2008 and open till 31st March 2009) carries an interest rate of 5.75%.

The 54EC Capital Gains Bonds issued by NHAI (starting from 26th May 2008 to 31st March 2009) also carry an interest rate of 5.75%.

 

So, should you invest in Section 54EC bonds?

Please read “Should you invest in Sec 54EC LTCG tax saving bonds?“. You would find a comparison between investments made in Sec 54EC bonds, and some other options.

 

2. Invest in Another House – Section 54 (Sec 54 of the Income Tax (IT) Act, 1961)

You can save the income tax on the LTCG from the sale of a house, if the long term capital gain is invested in another house.

You can save the LTCG by investing in a house even if you own other house(s).

 

How Much is Exempt

The amount of LTCG exempt from income tax is equal to the amount invested in the new house.

You can save the entire income tax on the LTCG from the sale of a house, if the entire long term capital gain is invested in another house.

Again, please note that you have to consider the amount of the long term capital gain, and not the entire sale proceeds.

Taking the same example as in the previous section, say you sell your house for Rs. 15 Lakhs, and your long term capital gain from this sale is Rs. 10 Lakhs.

Now, if you invest Rs. 10 Lakhs in a new house, you would not pay any income tax on this gain!

Instead, if you invest only, say, Rs. 7 Lakhs in a new house, you would have to pay a long term capital gain tax on the remaining LTCG of Rs. 3 Lakhs.

Thus, you would pay 20% of Rs. 3 Lakhs = Rs. 60,000 as long term capital gains tax.

 

When to Invest

The investment in a new house has to be made within a range in order to claim exemption (or relief) under section 54EC.

This range is: Upto 1 year before the sale of the house, or within 2 years after the sale of the house.

If the new house is being constructed (and not bought), such construction should be finished within 3 years of the sale of your house.

 

Capital Gains Scheme of Deposit Account (CGSDA) (Also sometimes known as Escrow Account)

If your intention is to buy a new house using the money received from the sale of your house, but you are unable to purchase it by the time you file your income tax return (this is 31st July in most cases), you have to deposit the money in a Capital Gains Scheme of Deposit Account (CGSDA) to claim the benefits of Sec 54.

The amount deposited in this account is deemed to be invested in another house. That is, the amount deposited in this account is treated as if you have invested it to buy another house.

The CGSDA can be opened in any branch of a public sector bank.

The amount deposited in a CGSDA has to be utilized for buying a new house within 3 years. If a new house is not purchased within 3 years using this amount, the entire amount is treated as long term capital gain for the previous year.

If only a portion of the amount is spent in purchasing a new house, the remaining amount is treated as long term capital gain for the previous year.

 

Period of Holding for the NEW House

There is one more condition for saving the income tax under section 54: The new house that is purchased has to be held for at least 3 years from the date of purchase, or from the date of completion of its construction.

This clause is very important, because if you do not follow this, you would undo all the benefit that you received through section 54.

What happens if this condition of holding the new house for 3 years is not satisfied?

When you sell this new house, while calculating the capital gain on its sale, the cost of this house will be reduced by the amount of long term capital gain (LTCG) that you invested in this house.

That is, the cost of this house will be reduced by the amount you claimed as exempt from tax when you purchased this house.

This effectively ends up increasing the profit that you show on the sale of this new house, and therefore, end up paying a lot more income tax than you should.

Let’s continue our example to understand this better.

You sell your house (House A) for Rs. 15 Lakhs, and your long term capital gain from this sale is Rs. 10 Lakhs.

You buy a new house (House B) for Rs. 20 Lakhs, and invest your gain of Rs. 10 Lakhs in it. You claim this investment of Rs. 10 Lakhs u/s 54, and therefore, you don’t pay any income tax on this gain.

Now, if you sell House B after 3 years for, say Rs. 25 Lakhs, your gain is Rs. 25 Lakhs – Rs. 20 Lakhs = Rs. 5 Lakhs, and you pay income tax on this (I haven’t factored in indexation just for simplicity – in an actual calculation, the cost of purchase should be indexed).

But if you sell House B before 3 years, for, say Rs. 25 Lakhs, your gain is:

Rs. 25 Lakhs – (Rs. 20 Lakhs – Rs. 10 Lakhs) = Rs. 15 Lakhs

And you pay income tax on Rs. 15 Lakhs!

(Here, we reduced the amount claimed by you as section 54 exemption from the cost price of the house).

Please also read:

- “Long Term and Short Term Capital Gain – Income Tax Calculation

- “Long Term Capital Gains (LTCG) on Sale of a House – Calculation and Income Tax

- “Set Off and Carry Forward of Losses – Capital Gains and House Property

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