For last couple of quarters, real estate prices have been rising very slowly. This has created a disappointment in investors who bought homes or apartments few years back hoping that the prices will move up and get them a handsome return. Not only that, once they sell their property, the taxman is always standing before you taking its share of flesh.  Thankfully, you can save taxes on selling your apartment.In this article, we will discuss the tax implication and the ways of saving taxes on the sale of property with an example. We will restrict our discussion to the sale of apartment as this is the most popular way of investing in real estate for most of the investors.

Calculation of taxes on the sale of apartment

Rahul is a manager in a financial firm in Pune and he has bought an apartment in July, 2003. The price he paid was 12.50 lakhs. He has sold the apartment in Dec 2012 at a price of 70.50 lakhs. Let’s first understand what the tax liability on Rahul from this transaction is.

Year

Cost Inflation Index

Cost Inflation Index* 2003-2004

463

Cost Inflation Index 2012-2013

852

   

Cost of house (in 2003-2004)

                                                                  1,250,000

Inflation adjusted cost of house

12,50000 * 852 / 463 = 2,300,216

   

Sale price

                                                                  7,050,000

   

Profit

                                                                  4,749,784

Tax (at 20%)

                                                                     949,957

   

VAT** to be paid - None. because it is applicable from 2006 onwards

 

*Cost inflation index: It takes care of inflation. Look at it this way. Suppose you bought a house at 10 lakhs and the price goes to 20 lakhs just because of inflation. In this case, it will be wrong to ask investors to pay tax on 10 lakhs profit if the apartment is sold. The cost price must factor inflation and then tax liability be calculated. Hence cost inflation index is a number that factors inflation in the cost of the house when bought.

**VAT: Maharashtra Government has decided to collect 5% VAT (value added tax) from owners who have bought their homes between 2006 and 2010. Apartments sold after 2010 will invite only 1% of VAT.

 

Saving taxes on the sale of property

Let’s see how can Rahul save taxes on the profit. There are few options available. We will focus mainly on buying another house to save taxes. Here are the details.

Item

 Values

Inflation adjusted cost of house (purchased in 2003)

                                            2,300,000

House sold in 2012

                                            7,050,000

Gain

                                            4,750,000

 

   

CASE 1 - Bought a new house which costs less than the gain:

Rahul buys another house which costs less than the capital gain experienced in selling his old apartment. Let’s look at the tax liability. Remember than when you buy a new house from the capital gain from selling old house, this new house has to be kept with you for 3 years. If you sell this before 3 years, you will have to pay taxes on the sale of new house.

Item

 Values

CASE 1 - Bought a new house which costs less than the gain

 

Bought another house

                                      4,000,000

Tax to pay on

                                          750,000

Suppose Rahul sells this new house within 3 years of purchase. In this case, he will have to pay taxes on the sale of new house. Since the price of this new house bought is less than the gain from selling old house, the cost of new house will be taken as zero. The liabilities will be as follows:

Rahul sells this new house within 3 years of purchase

 Values

Selling price

                                      7,000,000

Cost considered for new house

                                                      -  

Gain from selling new house

                                      7,000,000

Tax will be calculated on

                                      7,000,000

 

  

CASE 2 - Bought a new house which costs more than the gain:

Item

 Values

Bought another house

                                      5,000,000

Tax to pay on

                                                      -  

Again, suppose Rahul sells this new house within 3 years of purchase. In this case, he will have to pay taxes on the sale of new house. Since the new house is sold within 3 years and price of this new house bought is more than the gain from selling old house, the cost of new house will be equal to the cost of new house minus the capital gain arising from selling old house.

The liabilities will be as follows:

Rahul sells this new house within 3 years of purchase

 Values

Selling price

                                      7,000,000

Cost considered for new house

                                          250,000

Gain from selling new house

                                      7,000,000

Tax will be calculated on

                                      6,750,000

 

Finally

I have taken utmost care in giving the numbers as recent as possible. Governments are notorious in changing tax laws and rates on their whims and fancies and hence readers are advised to check the tax rates when they transact in real estate.

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