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Should you invest in Sec 54EC LTCG tax saving bonds?

When you earn long term capital gain (LTCG), you can avoid paying income tax if you invest the gain in Sec 54EC tax saving bonds.

But another option is to pay the income tax, and invest the balance amount in some other high-yielding avenue.

Which option makes more financial sense? What is better?



In “How to save / avoid Long Term Capital Gain (LTCG) Tax on Sale of a House”, we saw that you can avoid paying any income tax on your LTCG if you invest the amount of the gain in bonds that save you income tax u/s 54EC.

(To know how to calculate LTCG on sale of a house and the resulting income tax liability, please read “Long Term Capital Gains (LTCG) on Sale of a House – Calculation and Income Tax”. To know what is a capital asset, and to understand long term and short term capital gains, please read “Long Term and Short Term Capital Gain – Income Tax Calculation”)

Thus, you can end up saving a tidy 20% of the gain that you would have otherwise paid as income tax.


The Problem

The return offered by these bonds is very low – it is around 5.75% per year for most of these bonds.

This creates a dilemma: Should you invest in these bonds and save tax, or, should you pay tax and invest the remaining amount in some other instrument or avenue that gives a much higher return?

This is especially important in the current high interest rate scenario, when even bank fixed deposits (FDs) yield around 10% per annum!

So, let’s take an example, and find out which is better!

Example

Let’s say that you have made a long term capital gain of Rs. 10 Lakhs. (This is after taking into consideration indexation benefit).

You have two options: Saving tax by investing in Sec 54EC tax saving bonds, or paying tax and investing the amount somewhere else.

Let’s find out what the financial implication of each option is, and which option proves to be better! Since the lock-in of the bonds is 3 years, we would compare investments for 3 years.

(Download this spreadsheet that contains the full data and analysis.

You need to be logged-in to download the spreadsheet. Please take advantage of the free registration that takes less than a minute. To know the benefits of registration, please click here.)


Option 1: Save tax by investing in Sec 54EC tax saving bonds

Since you want to save tax, you invest the entire LTCG amount of Rs. 10 Lakhs in the bonds.

The rate of return is 5.75%. But remember: the interest on these bonds is not tax-free.

Thus, if you fall in the highest tax bracket of 30%, your post-tax return would be 4% per year.

At 4% interest rate, your Rs. 10 Lakhs would grow to Rs. 11,25,675 in 3 years.

Option 2: Pay tax, and invest in a high-yield avenue

The rate of income tax on LTCG is 20%. Thus, on a LTCG of Rs. 10 Lakhs, you pay a tax of Rs. 2 Lakhs, and you are left with a sum of Rs. 8 Lakhs for investment.

Now, you have two investment options: you can invest in a fixed deposit (FD), or you can invest in stocks – either directly or through a mutual fund (MF).

(To compare direct investment in stocks with equity investment using mutual funds, please read “Direct investment in Stocks versus Mutual Funds (MFs)”)

Investing in bank FD

Currently, bank FDs give interest rate as high as 10%. So, this seems like an attractive option!

Again, if you fall in the highest tax slab of 30%, your post-tax return would be 7% per year.

Rs. 8 Lakhs would grow to Rs. 9,80,034 in 3 years if invested at 7%.

(Download this spreadsheet that contains the full data and analysis.

You need to be logged-in to download the spreadsheet. Please take advantage of the free registration that takes less than a minute. To know the benefits of registration, please click here.)

Investing in Shares

Investments in stocks give the best returns in the long term. (To know more, please read “Stocks – The winning bet for the long term”)

A 3 year investment in stocks would be a medium term investment. You can expect a return of 12% to 15% on such an investment.

Let’s examine both these cases. Also, please remember that long term capital gain on investment in shares is tax-free. (To understand long term and short term capital gains and their income tax implications, please read “Long Term and Short Term Capital Gain – Income Tax Calculation”)

So, even the post-tax return would be 12% or 15% when you invest in shares.

At 12%, your Rs. 8 Lakhs investment would grow to Rs. 11,23,942. It would grow to Rs. 12,16,700 if you get a return of 15%.


Comparison of the Options






Option Instrument Amount after 3 years
1 Section 54EC Bonds Rs. 11,25,675
2a Fixed Deposit (FD) Rs. 9,80,034
2b Stocks – 12% Rs. 11,23,942
2c Stocks – 15% Rs. 12,16,700

As you can see, investment in an FD is the worst option – it gives the lowest return.

Investing is Section 54EC tax saving bonds and getting 12% return from the stock market give more or less the same result.

A return higher than 12% from investing in shares would give the best result.

(Download this spreadsheet that contains the full data and analysis.

You need to be logged-in to download the spreadsheet. Please take advantage of the free registration that takes less than a minute. To know the benefits of registration, please click here.)

So, what should you do?

Since investment in stocks gives a return equal to or better than investing in section 54EC tax saving bonds, you should be better off paying 20% LTCG tax and investing the balance amount in stocks.

But you should remember that a 3 year investment in stocks is a medium term investment, is carries some risk – especially when it is a one-time, lump-sum investment.

(What is the alternative to lump-sum investment in stocks? Read “Cost Averaging” for an excellent alternative)

So, if you are risk averse, you should invest the LTCG amount in Sec 54EC tax saving bonds.

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Comments

  1. Hi raag ,

    Let me first congratulate u for this excellent website. I visited your website few weeks back and I am hooked to it.
    I feel that there is a small error in the calculation of returns from stocks.( correct me if I am wrong) ,
    the post tax corpus available to us is 8 lakhs and not 10 lakhs as shown. When the corpus is 8 Lakhs for FD , isn’t the same for stocks also.

  2. Hi Aparna,

    Thanks a lot for the kind words – I am glad that I am able to help. And thanks a ton for the patronage :-)

    And yes, that is a typo – it should be Rs. 8 Lakhs even for stocks. but don’t worry – the resultant amount are still correct (they have been calculated using Rs. 8 lakhs as the starting amount). So, the conclusions still hold true.

    I have corrected the error now.

    Thanks again for pointing it out!

  3. Hi Chandru,

    Thanks for the suggestions… However, I am not sure what information you are exactly looking for…. Can you please explain? Thanks!

  4. Depositing in Bonds under 54ec should be the entire amount which is tax exempted. But when we invest partially like some amt under 54f and part on 54ec what is the proportion. Kindly explain this in your article then it is complete in all respect. Please add this calculation to make your point clear to viewers. otherwise this article is informative and useful for lay users of IT. Thanks and best wishes for the writer

  5. chandru v p says:

    May I invest ltcg of property sale partially in constructing a house and balance in ltcg bonds. For example ltcg is 30 lakhs. construction of a house 25 lakhs . may I invest balance 5 lakhs in ltcg bonds. Please clarify Thanks

  6. Hi Chandru,

    Yes, this should be possible.

  7. Guruduth says:

    Please confirm the followiing is true and valid:”The maximum amount that can be invested in capital gains bonds(NHAI) every year is Rs 50 lakh. However, if the long-term capital gains are more than Rs 50 lakh and accrued after October 1, the investor can split his investment into two parts. For one, Rs 50 lakh can be invested before March 31 and the rest (not more than Rs 50 lakh) can be invested on April 1. Tax benefits can be availed of for amounts up to Rs 1 crore. Is this correct sir?

  8. KRISHNAN MOHAN says:

    I purchased land for Rs.60,000 in June 1994 and constructed a house by taking bank hsg loan for 2.5 lacs. I sold the house for Rs.32 lacs in Dec2009. Ki ndly clarify whether interest paid on hsg loan for all these years can be construed as cost of acquisition and if so how to apply indexation? Moreover whether exemption u/s 54 and 54 EC can be availed simultaneously / i.e., whether I can buy land for 7.5 lacs for construction of a house in 3 years and invest 15 lacs in REC bonds to save tax on LTCG of 22.5 lacs. Your clarification would be of much help. Thanks & Regards.

  9. Uttam Kumar says:

    I’m selling agricultural land for 24 Lakhs. From this amount how much will be taxed and how to skip the Tax. Need full details.

  10. Anonymous says:

    I have a question on LTCG i.e. Long Term Capital Gain tax exemption through section 54.

    I bought an apartment in Bangalore in September 2004 with promise to get the apartment in January 2006 but thanks to the builder inefficiencies the construction only got completed in January 2007. On top of it because of some personal problems I could register the apartment only on March 27, 2007.

    Now I want to sell this apartment and invest that money into buying a villa. However, I want to avoid LTCG entirely so the question is…considering that I got the apartment registered only on March 27, 2007 what is the earliest date I take for registering the apartment in NEW owners name?

    Should I complete the registration only in April 2010 to safely state that 36 months were completed or can I go ahead and register the apartment in NEW owners name during 28-30 March 2010 timeframe?

    Regards,
    Jay

  11. SREEDHARAN says:

    Can I invest part amount in bonds to avoid capital gain tax

  12. Sunil Kumar says:

    If the LTCG amount is Rs. 1 crore, then can we invest Rs 50 Lakhs(i.e maximum Limit) in capital gain bonds and 50 Lakhs for the purpose of purchasing a new house simultaneously.

  13. Dear Mr. Raag,

    Accept my heartly thanks for the vast information.

    I have two queries.

    1. One house is sold by joint owners. Now, the capital gains can be invested by both the owners separately, i.e., whether the joint owners can purchase two properties in their individual names by investing their respective shares of capital gains?

    2. Can a part of the capital gains be invested in bonds also? That means two simultaneous benefits under Sections 54 and 54EC?

    Please tell me if there are judgments also on both the queries.

    regards
    manish

  14. Virupaksha says:

    Sir, my brother LTCG in sale of site is Rs.5 Lakh, may we invest this amount in Karnataka Housing Board Houses?

  15. The ‘”did you like this article?” prompt is very annnoying. Please do away with this or reduce the number of occurences. Thanks

  16. Hi thanks for ur insights regarding tax issues,I have a query…..I hv a commercial shop purchased in 1975 and am planning to sell the same, what wil be the implication of capital gain and what options will I have to reduce my tax liability
    Thanks

  17. We are a group of volunteers and starting a new scheme in our community.
    Your website provided us with valuable information to work on. You
    have done an impressive job and our whole community will be grateful to you.

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