You bought a property in 1998 in 12 lakhs. This is 2013 and prices seem to have peaked. You decided to sell your property and you got a customer willing to pay a sum of Rs 60 lakhs. You are gung-ho about receiving such a big sum and then you read about long term capital gain (LTCG) taxes. Almost 1/5th of your profit is going to go to the Government. You wonder whether this is going to be right decision. When you analyse post tax gains, your enthusiasm plunges.
There is inflation indexation to reduce your tax liability but this is your right. After all, you pay taxes on the real gain and not the nominal gain which doesn’t factor inflation. However, you are a smart fellow. You know there must be some ways to save taxes. After all, tax incentive is a way to increase economic activity. Governments are not foolish enough not to give any leeway to save taxes.
Long term capital gain
Long term capital gain taxes are levied when you sell property after 3 years. The rate of LTCG is about 20% with other obligations. This is after you take into account the cost inflation index in your calculation. Please see the use of cost inflation index to reduce your tax liability here.
Different ways to save taxes
There are many ways to save taxes. However, individuals should not follow this just to save taxes. Look at your requirement and decide accordingly. Investing to save taxes is the least effective way to manage your money. The exception is investing in ELSS that gives better returns but ELSS is not available in this scenario.
Buy another property
You can save taxes by buying another property with the money you received by selling your property. In this case, you do not have to spend all the proceeds to save taxes but just the profit. For example, in the case shown above, if you buy another property worth 48 lakhs, your tax liability will be zero. If you buy property worth 35 lakhs, you will have to pay LTCG on remaining 13 lakhs. I am ignoring the cost inflation index here. The idea is to convey that you can save taxes on your capital gain.
This can be done in three ways:
Case 1 – If you have already bought a property within 1 year before selling the property, you can claim that amount as deduction from your profit provided the cost of new property doesn’t exceed the profit on old property.
Case 2 - You have to buy the property within 2 years of selling your previous property.
Case 3 – If you are going to construct on your own, this should be completed within 3 years after selling the old property. If you are buying an under-construction property, this should be completed within 3 years.
The important condition is that you have to keep the new property for at least 3 years. If you do not fulfil this, all the tax savings you did will be undone and you will have to pay taxes.
Invest in bonds
There are few bonds issued by National Highway Authority of India (NHAI) and few other Government enterprises. Investing in these bonds can come handy if you are not able to select a property to invest and save taxes. Investing in these bonds come under section 54EC. The rules are similar. You get tax exemption on only the amount which you have invested in these bonds permissible to maximum limit of long term capital gain.
You have to invest your LTCG within 6 months to avail this opportunity. The maximum limit is 50 lakhs in a financial year. Hence if you can manage the timing, you can save taxes on 1 crore. For example, suppose you sold your property in December and made a capital gain of 1 crore. Since you can invest up to Rs 50 lakhs in a financial year, you can invest 50 lakhs in January and remaining 50 lakhs in April. By this way, you are fulfilling both the condition of availing the tax savings under 54EC. The other condition is that you have to remain invested for 3 years at least to get the benefit.
Deposit in escrow account
This account is also known as Capital Gains Scheme of Deposit Account. If you think it would take more time to buy a new property, you can deposit the gain in this account. This account is like an escrow account where the money is taken as a guarantee that you will buy another property. The time limit is 3 years. It means you have to buy the property within 3 years. You can open this account in any Government bank.
Important points to remember
First, find out the rationale behind saving taxes. Let’s take the first case. There is no point buying another property just to save taxes unless the location of the new property has potential to become attractive in future. If you are stuck with a property with little or no increase with valuation, you are only foregoing the returns that could have accrued from other investments. Moreover, remember that you sold the property to receive gains and not block your gain in another property.
Second, investing in bonds under article 54EC incurs very low returns. These bonds give you a return of 5% to 7% which is very low. Moreover the return is taxable. Hence your effective return further goes down. Investors should see whether they can do better with their investment than earning small returns just to save taxes.
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