TAXATION AND REAL ESTATE By Manoj Abraham(Roll no:- 130) Buying a property and selling it at a higher price later is very common. Since, most investors sell their property at a profit; every profitable sales transaction attracts a certain tax liability. The tax rate however depends on several factors. As the amount involved in sale/purchase of a property is usually very high, the resultant tax amount is also very high! So to reduce the tax burden for investors, the Government of India has laid down several alternatives for availing tax exemption under the Income Tax Act. Before computing the net tax liability and investing your funds in the right avenues to save tax, it is first important to understand the classification of your gains arising from the sale of a property. A property held for 3 years or less, attracts Short-Term Capital Gain (STCG), when sold at a profit. The gain from this sales transaction is added to the tax payer’s income and taxed as per the income tax bracket he falls under. For instance, if a tax payer falls under the tax slab of 30 percent, the STCG will also be taxed at the rate of 30 percent. The tax on STCG however, is not eligible for any type of exemption. The tax payer is liable to pay Long Term Capital Gain (LTCG) if he holds a property for more than 3 years before selling. Since the LTCGs are usually very large, there are several provisions available to reduce the tax burden arising from these transactions. Some of these are indexation, lesser tax rate and deductions available as per income tax act. To reduce the tax burden, indexation factors inflation in its calculation by using the Cost Inflation Index. Please read my article on “Capital Gains” to understand in detail the computation of capital gains. The tax rate of 20 percent on LTCG brings down the amount of tax payable significantly as compared to the STCG tax (where STCG is 30%). Apart from this, there are several exemptions/ deductions available to reduce the LTCG tax burden of the assessee. These deductions are available in the following circumstances: a) LTCG arising due to sale of a residential unit and investment made in a new residential unit; b) LTCG arising due to sale of an agricultural land and investment made in a new agricultural land; c) LTCG arising on compulsory acquisition of lands and buildings of an industrial undertaking and investment made for purchase of land or building to shift or re-establish the industrial undertaking; d) LTCG arising from transfer of machinery or plant or building or land of an industrial undertaking situated in an urban area and an investment made on machinery or plant or building or land for the purpose of shifting the industrial undertaking to any area other than urban area; e) LTCG arising on sale of asset other than a residential unit and investment made in a residential unit; f) Investment in financial assets; g) Investment in equity shares. You can avoid paying LTCG tax partially or completely if you invest your funds wisely. The Income Tax Act allows several exemptions for saving your LTCG tax liability. It is important for an investor to be aware of these exemptions to lessen his tax burden. Following are some of the popular ways to save Long Term Capital Gain tax: 1. Investment in residential property within a specific time frame (Section 54/ 54F): As per the income tax provisions, LTCG arising from sale of a capital asset (residential or non-residential property) is exempt under Section 54/54F if the net sale proceeds are invested in purchase or construction of one residential property, subject to following conditions: Condition (i): The investor/seller should use the funds from capital gain to purchase a new residential house within 1 year before or 2 years after the transfer date (sale/transfer of the original property). Condition (ii): If the investor intends to invest his money in an under-construction residential property or construct his own residential property, the construction needs to be completed within 3 years from the date of transfer of the original property. Condition (iii): The investor should not own more than one house (other than the new house) on the date of sale or purchase. Or, should not construct any residential house (other than the new house) within a period of three years, after the sale date. Condition (iv): The investment in a new residential property has a lock-in period of three years. If the new property is sold within a period of three years, the exemption claimed with respect to the old property shall be revoked and the capital gains become taxable. Condition (v): If the amount invested for buying a new house is more than the capital gain, then the maximum amount of tax exemption should be restricted to proceeds from LTCG invested for buying a new house. In other words, maximum exemption cannot exceed the amount of LTCG used for buying a new house. The balance amount of LTCG (after investing in new property), if any, is taxable at 20%. Condition (vi): As per union budget for FY 2014-15, for availing the benefit of LTCG tax exemption, the investment should be made only in one residential house property situated in India, not abroad. 2. Deposit funds in Capital Gains Account Scheme (CGAS): To avail tax benefit, the capital gains should be re-invested in a residential property before filing income tax return for that year. If you are unable to find the right property or invest that money in another property before the due date (usually 31st July) of filing your tax return, then the unutilized sale proceeds can be deposited into Capital Gains Account Scheme (CGAS). Taxpayers can avail exemptions under the CGAS only when the amount of capital gain, or net consideration, is deposited by the last date for filing the income tax return. There are 2 categories of Capital Gains Account:- Deposit Account Type A: All deposits into this account are in the form of savings. This account is suitable for taxpayers who want to construct a house over a long period as withdrawals are permitted according to the provisions of the scheme. Deposit Account Type B: This account is similar to a term deposit as it is payable after a fixed time duration. The depositor can opt to keep the deposits cumulative or non-cumulative and withdrawals from this account can be made only after a stipulated duration. The Capital Gains Account however, is only a temporary arrangement to park your funds for 2-3 years. The withdrawals from these accounts should be made to pay for purchasing/constructing a residential property only. 3. Investment in bonds (Section 54 EC): LTCG arising from the transfer of any long term capital asset are exempt under section 54EC if the investor, within a period of 6 months of sale, invests the capital gain in notified bonds issued by the National Highways Authority of India (NHAI) or Rural Electric Corp. (REC) Ltd for a minimum period of 3 years. This is restricted to a cap of Rs.50 lacs per financial year. These bonds are also known as capital gain bonds. An investor who wishes to claim the exemption from LTCG tax has to invest the amount in the capital gain bonds within 6 months from the date of sale (of property) or before the due date of filing income tax return (usually 31st July), whichever is earlier. The interest rate offered on above mentioned bonds is currently 6% and the interest income from these bonds is not tax-free. Tax treatment for Capital gains is different from regular income. It is important for an investor to be aware of its computation and the availability of various options to save his/her tax liability. SAVING TAX You cannot avoid tax on short-term capital gains. However, you can claim deductions to lower the tax liability on long-term gains. Buy a house: Houses are a popular investment option. Long-term capital gains from selling a house get tax exemption if they are invested in buying or building a new house. The new house has to be bought one year before the transfer of the first house or within two years after the sale. The deduction allowed is equal to the actual investment or the capital gain, whichever is lower. If you plan to use the gain to build a house, it has to be done within three years of the sale of the property. When you buy a plot to build a house, the cost of land is included in the construction cost. Even buying an under-construction property entitles you to tax deduction. "One can buy an underconstruction apartment to save capital gains tax, provided its construction is completed within three years of the transfer of the first property," says Kaushik. If the new property is sold within three years of purchase or construction, the deduction is reversed and taxed as short-term capital gain. Let us say you purchase a new house for Rs 15 lakh and claim a deduction of Rs 10 lakh. The exempted amount will be deducted from the purchase cost for calculating the capital gain in the next three years (Rs 15 lakh-Rs 10 lakh). Now suppose you sell this house after two years for Rs 25 lakh. Your capital gain will be Rs 20 lakh (Rs 25 lakh-Rs 5 lakh), even though the actual appreciation is only Rs 10 lakh. If you buy an under-construction independent house and resume construction, the cost incurred in further construction will also be eligible for tax exemption under Section 54 of the Income Tax Act, says Kaushik. In cases where capital gains have been made by selling land (or any asset other than a house), the investments required for deductions are different. Full deduction is allowed (under Section 54F) in cases where the entire sale proceeds are invested in a new house or used to build a new house. If you use a part of the money, the deduction will be proportion of the invested amount to the sale price. The time-frame for investment is the same as that for capital gains from residential property. You should not own more than one house prior to the investment. The deducted capital gain (from non-house assets) becomes taxable if you buy a new house within one year of the transfer of the original asset or construct a new one within three years. If the new house is sold within three years, the deduction claimed will become taxable as a long-term gain. If you do not want to lock the entire proceeds in a residential property, you can invest the capital gain in specified bonds. BANK ACCOUNTS Buying or constructing a house generally takes a long time. If you fail to make the investment before filing your tax return for the financial year, you can still avail of the deduction by letting the taxman know about your plan using the Capital Gains Account Scheme (CGAS). "An individual can deposit the capital gain in an account opened under the Capital Gains Account Scheme with any public sector bank if it has not been fully utilised for purchase or construction of a new property. This has to done before the deadline for filing the return," says Kaushik of TaxSpanner.com. The deposited money can be used only to buy or construct a residential house within the prescribed time frame. Failure to do so will lead to taxation of the unutilised amount as long-term capital gain after three years of the sale of the first property. There are two types of capital gains deposit accounts-savings deposits (type A) and term deposits (type B, with cumulative or noncumulative interest options). You can transfer money from one to another by paying fixed penalties or charges. You can withdraw money from type A accounts by giving a declaration that the money will be used to buy or construct a house. In such a case, you will have to use the withdrawn money within 60 days and deposit the unutilised amount, if any. The interest rates paid on these accounts are the same as those on regular savings and term deposits. You will have to pay tax on the interest earned as it accrues in your account, but it cannot be withdrawn. You will have to attach the proof of the deposit with your return. If the deposited amount is not used fully to buy/construct a new house, the remainder will be treated as capital gain at the end of three years from the date of the sale of the original asset.