Residential property and Tax on capital gain

When investors make profits on sale of assets like land, shares and mutual fund units, it is termed as capital gains. The investor has to pay tax on the resulting gains that is commonly referred to as capital gains tax. The amount of money outflow from your pocket depends on how long you held the property.

If a residential property is held by the seller for more than 24 months, it is considered a long-term investment. For investments over the short term, the short-term capital gain is added to your total income. You will be taxed depending on the tax bracket you fall in. When computing long-term capital gain, a bit more complexity is involved. Indexation is the process by which inflation is taken into account and the purchase price is proportionately increased. Consequently, the amount you end up paying as tax is reduced.

If you have sold a residential property for a profit, you can expect some relief on the capital gains tax payable, if you meet certain conditions. If the property you sold was held by you for at least three years – it is a long-term asset – you are entitled to relief if you buy a new house within two years from the date of sale. For those who are constructing a house, the work should be completed within three years from the date of sale. The final condition to be eligible for exemption is that the cost of the new house should be at least equal to the capital gain.

Let us see how to compute capital gains. Suppose a house was purchased for Rs 10 lakhs and sold for Rs 30 lakhs after four years. The transaction falls under the long-term capital gains bracket. The government publishes a cost inflation index (CII) chart for every financial year, which is used for indexation.

You must subtract the actual sale price from the actual cost of purchase to arrive at long term capital gain. To save on tax on this amount the seller must reinvest the money within two years from the sale date.

Long-term capital gains on sale of a house can be deposited under a Capital Gains Scheme of any authorised bank before the due date for filing of return of income. This may not be relevant for sellers who have already invested the entire capital gains in another house subject to conditions. The amount deposited here is considered to have been used for the purchase or construction of the new house. If the amount you have deposited is not used for buying a new house within a period of three years, the amount will be treated as long-term capital gain of the previous year.

Section 54 provides exemption on long-term capital gains arising on sale of residential property and investment of such capital gains in another residential property. The law envisages a time limit within which the investment should be made. That is two years for purchase and three years for construction. But if after the sale of the property, you cannot find another property of your choice, the amount of capital gain should be kept in any authorised bank under a Capital Gains Accounts Scheme till investment.

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