Capital Gains refers to a profit that one make while selling an asset. Under Section 80C of the Income Tax Act, such profit can be considered as an “income”. Naturally, you’ll need to pay the applicable tax on the amount in the concerned financial year when the asset was sold. Now that is called Capital Gains Tax.
In other words, the capital gains tax is the tax that is levied on the profit that an investor makes when an investment is sold. In other words, the investor needs to account for the tax year during which the investment is sold.
However, capital gains tax is not applicable in case a person gains an asset via inheritance or will. Taxability occurs when the inherited property is resold to another.
According to the Income Tax Act, capital gains tax can be exempted as long as the investor re-invests in the construction or purchase of a residential home or in capital gain bonds. The investor might choose to pay a 20% Long Term Capital Gains Tax or he can seek for exemption.
Capital Assets
What falls under the Capital Assets category?
- Any land (including agricultural land)
- building
- patents
- machinery
- real estate
- trademarks
- vehicles
- leasehold rights,
- and jewellery.
What does not fall under the Capital Assets category?
- Any stock or raw materials that are held for business purpose
- Personal items such as clothing and furniture
- Agricultural lands in the rural part of India
- Government-issued national defence bonds or 7% gold bonds or 6 ½% gold bonds
- Special bearer bonds
- A gold Deposits bond that is issued under the gold deposit scheme.
Two-types of Capital Assets:
- Short-term asset
- Long-term asset
Here’s the step-by-step guide on how to claim such exemptions on the sale of a long-term asset.
Residential Property not transferred within 3 years of the date of acquisition (u/s 54 of Income Tax Act)
Any long-term capital gains made by an individual or HUF from the sale of a residential property (whether the property is their own or rented out) are free from taxes to the degree that they are invested in:
- The acquisition of a second residential property during a period of one year or two years following the transfer of the sold property; and/or
- Within three years of the property’s transfer or sale, a residential building must be constructed.
A short-term capital gain
The cost of purchase of this home property shall be reduced by the amount of capital gain exempt under section 54 previously if the new property is sold within three years of the date of acquisition, for the purpose of computing the capital gains on this transfer.
Deductions under Section 54
Under Section 54, total deductions will depend to the extent of the capital gains that are used to fund the purchase and building another home. Excluded if:
- amount is equal to or less than the cost of the new home.
- capital gain exceeds the cost of the new home.
Exemptions under Section 54
- According to the Finance Act of 2014, the Capital Gains Exemption is only valid if it is used to fund the building or purchase of a single residential home.
- As an exception to the aforementioned regulation, the capital gains exemption would be permitted even if the investment was made in the acquisition or building of two residential homes in circumstances where the amount of capital gains does not exceed Rs. 2 Crores. However, you may only utilise this exemption once if you buy two residences for residential use.
Once the exemption is availed, it cannot be used again in any other year.
Scheme for Capital Gains Accounts
The capital gains on the transfer of the original home property are taxable in the year in which it was sold, even though Section 54 gives the assessee two years to buy the house property or three years to build the house property.
The applicable assessment year’s Income Tax Return for that year must be submitted on or before the deadline for submitting the Income Tax Return. Therefore, the assessee must make a choice on the purchase or building of the residential property by the due date for filing an income tax return , otherwise the capital gain will be taxed.
The Income Tax Act offers a substitute in the form of a deposit under the Capital Gains Account Scheme to avoid the aforementioned circumstance.
Before the due date for filing the income tax return , the assessee must deposit any capital gain funds under the Capital Gains Account Scheme that were not used for the purchase or building of a new home. When claiming the Capital Gains Exemption, the Income Tax Return must include the deposit data, including the Date of Deposit and the Amount Deposited. In this scenario, the assessee will be entitled for an exemption on the money previously used for the purchase or building of the new home.
If the assessee deposits money in the Capital Gains Account Scheme but does not use it to buy or build a home within the required time frame, the money will be charged as capital gains for the financial year in which the required three years have passed since the original asset was sold. This will be a long-term capital gain.
Allocation of a flat or house under delayed possession
The DDA’s allocation of a flat under the Self-Financing Scheme will be deemed to have occurred during the building of the home (Circular No. 471, dated 15-10-1986).
A similar distinction is made between the construction of a dwelling and the allocation of a flat or house by a co-operative organisation to which the assessor is a member (Circular No. 672, dated 16-12-1983). Additionally, even when the work is not finished by the deadline, the assessee is still eligible to request an exemption from capital gains in certain situations [Shashi Verma v. CIT (1997) 224 ITR 106 (MP)].
The Delhi High Court used the same analogy in CIT v. R.L. Sood (2000) 108 Taxman 227 (Del), where the assessee made a sizable payment within the allotted time frame and subsequently acquired a sizable domain over the property even though the builder failed to transfer possession within the allotted time.
Vidya Prakash Talwar, CIT (Addl.) v. (1981): House Property does not always refer to a finished Independent house. It includes any residential unit whether apartment or a flat.
Unutilized deposit amount is not an income
In the event that a person passes away before the 2/3 years allotted under sections 54, 54B, 54D, 54F, and 54G, the unutilized deposit amount in the Capital Gains Account Saving Scheme cannot be taxed in the hands of the dead.
The unutilized component of the deposit does not have the character of income in their hands; rather, it is merely a piece of the estate, thus this amount is not taxable in the hands of the legal heirs as well.
Transfer of any long-term capital asset
If the assessee invests the capital gain within six months of the transfer’s due date in long-term designated bonds as announced by the government for a minimum of three years, the gain from the transfer of any long-term capital asset is exempt under section 54EC.
In the event that the long-term specified asset is transferred or converted into money within three years of the date of purchase, the amount of capital gain exempt under Section 54EC will be regarded to be the long-term capital gain of the year before to the transfer or conversion.
The long-term designated asset will be considered to have been turned into money on the date that the loan or advance was taken by the Assessee if he even accepts a loan or advance against it.
The Interest Rate provided on these specified contracts, which are typically issued by REC and NHAI, is around 5.25 percent. Since the interest is not tax-free, tax must also be paid on the interest generated. These bonds aren’t tax-free bonds; they are capital gain bonds. After the lock-in period, the invested Principal is no longer subject to taxation, but the interest is still taxable.
Deductions under Section 54EC
- If capital gains are invested in the long-term defined assets within six months of the transfer date (up to a maximum of Rs. 50 lakhs), they would be free from tax.
- The budget for 2014 additionally included a change to Section 54EC, which states that starting in the next financial year, or AY 15-16, an assesse’s investment in a long-term defined asset made from capital gains from the transfer of one or more original assets cannot exceed Rs. 50 lakhs.
Section 54F:
If the entire net sales consideration is invested in, any gain that a person or HUF may realise from the sale of any long-term asset other than residential property will be completely excluded.
- Buying a single residential property within a year of the transfer of such an asset, within two years of that date, or within three years of the transfer date, build one residential home
- Three years of the transfer date, build one residential home
When Section 54F exemption is not available
If any of the following circumstances are met, the aforementioned exemption would not be valid: –
- On the date of transfer of such asset, the assessee does not hold more than one residential house property, excluding the one he purchased in order to qualify for an exemption under section 54F. (Note: Only if the assessee is requesting an exemption under Section 54F is the restriction on the number of homes previously owned relevant. As previously stated, if the assessee is seeking exemption under Section 54, there is no such restriction.
- Within a year following the transfer of the old asset, the assessee purchases any residential property aside from the new asset.
- Within three years of the old asset’s purchase date, the assessee constructs any residential home, except the new asset.
Recent Changes
Budget 2018 Amendment:
Beginning with the Financial Year 2018–19, only sales of land or buildings would be eligible for the Section 54EC benefit (whether Residential or Non-Residential).
Previously, it applied to all assets, but it is now only relevant to land or buildings. Additionally, these bonds must be held for a minimum of 5 years starting in the Financial Year 2018–19.
A change to Section 54F was also made in Budget 2014, and it would take effect in FY 2014–14. Under this change, an investment in a single residential dwelling in India qualifies for the exemption.
Investment in two homes would prevent Section 54F exemption from being granted.
In Section 54, but not in Section 54F, you have the opportunity to invest in two homes once in your lifetime.
Prior to the deadline for filing an income tax return , the Assessee may also deposit this sum in the Capital Gains Account Scheme described in Section 54 above.
