Selling a Home? Explore Capital Gains Tax Around Real Estate
How To Navigate Capital Gains With Real Estate

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Your home is a special place for you and your family where you create memories together. Sometimes though, we decide to move on from a particular home. While there can be many reasons to sell a house, it is also a process that comprises finding the right buyer, getting the best price etc. Also, a part of this process is having a plan for the tax that derives from the capital gains or profits. This means if you sell your home at a profit, or more than its purchase price, you may have to pay some tax on these profits. Let’s explore what capital gains tax on real estate looks like and how it can affect your finances and tax planning.

Understanding Capital Gains Tax
Capital gains are the income or profit from trading, that is, buying and selling assets. These assets can be real estate, commodities, stocks and other financial instruments. The profits from selling such assets are called capital gains and they attract a tax called capital gains tax. For example, if you buy a house for Rs 2 Crore, and sell it for Rs 3 Crore, the capital gains will be Rs 1 Crore and this profit will be taxable.

Further, different financial investments attract varied capital gains tax. For instance, when you invest in stocks, long-term capital gains tax is paid at 10% after a holding period of a year. Real estate capital gains tax is calculated based on the cost of acquiring the asset, the price at which it is sold, the duration for which the asset is held, and the amount of profit generated. Let’s delve deeper.

Types of Real Estate Capital Gains Tax
When it comes to the profit generated from real estate sales, you have long-term and short-term capital gains, both taxed differently in percentage based on the duration of holding. Short-term in real estate is defined as 24 months or less of holding an immovable asset – like land or a residence. However, assets held for longer than 24 months are considered long-term.
You can consider this table as a summary of how profit from the sale of real estate can be taxed.

Duration of real estate holding Type of gain Tax rate
Property held for up to 24 months Short-term capital gain Gain added to individual income and taxed as per slab
Property held for more than 24 months Long-term capital gain 20%

How do capital gains affect your tax bill?
When you sell your house, you may make a profit. This is calculated based on the price of the sale minus the price of the home purchase. However, real estate also has ancillary expenses like property alterations, improvements, and repairs. These expenses are subtracted from the final sale price to reflect the extent of the real profit.

Let’s explore some of the components required to calculate short-term as well as long-term capital gains and their subsequent tax.

  • The full value or sale price received from the sale of the property
  • Initial acquisition cost or purchase price of the property
  • Cost of alterations, improvements, and repairs undertaken for the property – such as civic work, plumbing, or electrical work
  • Expenses related to the sale and/or transfer of the property – such as brokerage and stamp duty.

In the case of long-term capital gains, the purchase price of the house and its repairs receive the benefit of indexation. For example, a house purchased for, say, Rs 1 Crore in 2012 can be considered as purchased for a higher amount, say, Rs 1.5 Crore in 2018 based on the Central Inflation Index (considering the inflation). If this house is sold for Rs 2 Crore in 2018, then the capital gains from it will be calculated at (2 – 1.5) Cr rather than (2 – 1) Cr, thereby reducing your taxable capital gains on a house.

This means that the purchase price of the home and its key repairs shall be calculated at today’s price, to more accurately reflect their value, thereby reducing the tax you are liable to pay.

Strategies to manage capital gains tax

If you are seeking a solution to reduce your tax obligation from the sale of your home, there are a few ways to achieve this. There are a few smart things you can do to manage your property capital gains and minimise your tax burden. These routes are laid out under Section 54 of the Income Tax Act, 1961, which lists the tax exemptions from the sale of a house. The following subsections offer tax incentives related to real estate transactions:

  • Section 54: The capital gains tax from the sale of a house can be exempt from long-term capital gains (LTCG) tax by purchasing or constructing up to two houses, within a certain period from the sale date. This period depends on the type of real estate you are investing in. Up to Rs 2 crore can be exempt from tax through this method.
  • Section 54F: This section allows you to claim LTCG tax exemption from the transfer of any type of asset (excluding a residential house) by investing the proceeds in buying or constructing a home, within a certain period from the sale date.
  • Section 54EC: By investing up to Rs 50 lakh of capital gains in bonds issued by the National Highways Authority of India (NHAI) or Rural Electrification Corporation (REC), you can exempt the invested amount from your tax bill.

Capital gains: Laws, documentation & exemptions
Let’s explore Section 54 in simple detail to understand how to use capital gains from a real estate sale prudently.
Let’s assume Jay has a house worth Rs 3 crores, purchased at Rs 1.2 crores. He sells this house at its market value. Now, Jay has three tax choices:

  1. He can pay the full amount of capital gains tax from the sale of the house.
  2. He can seek an exemption from the capital gains from the sale of his house by investing these gains in up to two residential houses. The amount of tax allowed to be exempted through this method is under Rs 2 crores under Section 54 of the Income Tax Act.
  3. He can minimise his tax bill by investing up to Rs 50 lakh in bonds issued by the NHAI or the REC for 5 years. The amount he invests in these bonds will be exempt from his capital gains tax bill under Section 54 EC of the Income Tax Act.

Market trends & other considerations
The best practice for buying a home, whether it is for investment, residence, or to minimise the tax bill is to hold it for a long period. Real estate purchases have various qualities not found in other assets. Think of the tangibility of a space, as well as how it diversifies your asset portfolio. Real estate also holds attributes of tax exemption. Your own home is special for emotional reasons as well – it is your own space to express yourself and make memories. Further, homes can even be a rental income asset when not used by you and your family.
By holding on to a real estate asset for longer, you not only improve your odds of getting a meaningful return, but you also improve how you will be taxed. If someone with a residential property, agricultural land, and other assets at the same time, they will be in substantial tax debt. However, by spreading out such sales over some time, they can stagger their tax payments and consider options that suit their larger financial goals and needs.