No Idea about Capital Gain Tax but Property Under Redevelopment? Here’s all you Need to Know!!

No Idea about Capital Gain Tax but Property Under Re-Development? Here’s all you Need to Know!!

The Finance Act, 2017 inserted a new sub-section 5A in section 45 which deals with the capital gain in case of re-development of any land or building or both. But first, let us understand the meaning of capital gain in case of sale of an immovable property.

WHAT IS CAPITAL GAIN IN CASE OF IMMOVABLE PROPERTY?

Capital gain is the profit or gain arising upon transfer (sale) of any capital asset (in this case, land or building or both). This capital gain is calculated by deducting the cost of acquisition (purchase cost) or the cost of improvement (like repairs, reconstruction etc.) of the capital asset from the sale consideration received upon transfer. We can loosely tabulate this as below:

PARTICULARS	AMOUNT
Sale consideration	xxx
LESS: Cost of acquisition (or indexed cost of acquisition in case of LTCG)	xx
LESS: Cost of improvement (or indexed cost of improvement in case of LTCG)	xx
CAPITAL GAIN (SHORT TERM OR LONG TERM)	xxx

Such capital gains may be either SHORT TERM CAPITAL GAIN (STCG) or LONG TERM CAPITAL GAIN (LTCG).

• Short term capital gain means capital gain in case of asset which is held for not more than 24 months, i.e. when the asset is sold within 2 years of purchase, the gain is “short-term”.
• Long term capital gain means gain in case of asset which is not short term, i.e. when the asset is sold after 24 months of purchase, the gain is “long-term”.

The capital gains (short term or long term) are taxed at a flat rate of 20% in the financial year in which the transfer takes place.

The primary reason to bifurcate the capital gain into short term or long term is that in case of long term capital gain, the seller can avail the benefit of “INDEXED COST”. Indexed cost means the cost of acquisition or improvement of capital asset as adjusted by the cost inflation index. Since the period of holding of any immovable property can be very long, it is only logical to adjust the cost of purchase of the property with inflation. Such indexed cost is not calculated in case of short term capital asset since the period of holding is quite less. It is crucial to note here that this “cost inflation index” for the purpose of calculation of indexed cost is standard and is provided every year by the income tax department.

Let’s take an illustration here to understand more clearly the capital gain in case of sale of immovable property. Let’s say that Mr. V sells a residential flat to Mr. A on 5^th February 2021 for Rs.10,00,000/-. Mr. V had purchased that flat on 7^th July 2017 for Rs. 4,00,000/-. What will be the capital gain to Mr. V in this case?

SOLUTION: We can clearly see that since Mr. V had purchased that residential flat on 7^th July 2017 and sold the house on 5^th February 2021, the period of holding is more than 24 months and the gain will be a long term capital gain.

We can calculate the long term capital gain as follows:

PARTICULARS	AMOUNT
Sale consideration	10,00,000
LESS: Indexed cost of acquisition: Rs.4,00,000 * 301 / 272 (See Note 1)	4,42,647
LESS: Indexed cost of improvement	NIL
CAPITAL GAIN (LONG TERM) TO BE TAXED IN FY 2020-21	5,57,353

Note 1: The cost inflation index for the FY 2017-18 in which the asset is purchased is 272 and for the FY 2020-21 in which the asset is sold is 301. 

TAX EXEMPTION AVAILABLE AGAINST CAPITAL GAIN IN CASE OF RESIDENTIAL PROPERTY

There are numerous sections under which exemption from such capital gain can be availed upon fulfillment of certain conditions. Here, we shall discuss only the section 54 which is related to exemption in case of residential house property which is the most important and widely used.

Section 54 provides exemption from capital gains tax if the following conditions are satisfied:

1. The capital asset is a long term capital asset i.e. the holding period is more than 24 months.

2. The amount of capital gain is reinvested through purchase or construction of another residential house.

3. In case of purchase of residential house, purchase should be done either 1 year before or 2 years after the date of transfer of the original residential house.

4. In case of construction of residential house, construction should be completed within 3 years from the date of transfer of the original residential house.

5. In case the full amount of capital gain is not reinvested as per condition 2, exemption will be available only up to the amount so reinvested.

6. Till the time the reinvestment is not done, the amount relating to capital gain should be kept in a separate account under Capital Gain Account Scheme (a special account that can be opened with any scheduled bank).

Thus, in our above example, if Mr. V reinvests his capital gain of Rs.5,57,353/- (or more) to purchase or construct another residential house within the time limit specified under condition 3 or condition 4, as the case may be, then he will get exemption from such capital gain.

SPECIAL CASE – CAPITAL GAIN IN CASE OF RE-DEVELOPMENT OF IMMOVABLE PROPERTY (S. 45(5A))

In the special cases which a building or a land is given to a developer for re-development or refurbishment, there are actually two separate transactions (transfers) that are taking place:

TRANSACTION 1: Transfer of our share of property to the real estate developer for re-development (the date of such transfer is deemed to be the date of agreement for re-development).

TRANSACTION 2: Upon completion of re-development – transfer of our new share in the redeveloped property by the real estate developer (the date of such transfer is deemed to be the date on which completion certificate is obtained).

The section 45(5A) provides a benefit to the assessee whose property undergoes re-development – that even though the transfer of property takes place on the date of agreement of re-development (see TRANSACTION 1 supra) – the capital gain tax will be levied only upon completion of re-development i.e. when completion certificate is obtained – and not on the date of transfer. This basically defers only the taxation on the capital gain up to the date of completion of re-development and does not defer the date of transfer. A silver-lining in this provision is that the indexation benefit available in case of long term capital asset shall be available only up to the date of transfer (i.e. the date of agreement) and not up to the date of completion of re-development.

Now, a question arises that in these transactions, since there is no actual inflow or outflow of payment through bank or cash, how will the sale consideration be determined? Section 45(5A) also provides answer to this question by deeming that the sale value shall be the stamp duty value (guideline value) of the share of property received upon re-development.

Let’s continue our above illustration and say that instead of selling the residential flat, Mr. V enters into an agreement of re-development with a real estate developer Mr. A on 1^st January 2020. The certificate of completion of re-development is received on 5^th February 2021 and Mr. V receives a new residential flat whose stamp duty value is Rs.10,00,000/-. What will be the capital gain in the hands of Mr. V and when will the gain be charged to tax?

 SOLUTION: In case of re-development agreement, we can calculate the capital gain as follows:

PARTICULARS	AMOUNT
Sale consideration (stamp duty value of share of property received upon re-development)	10,00,000
LESS: Indexed cost of acquisition: Rs.4,00,000 * 289 / 272 (See Note 1 & 2)	4,25,000
LESS: Indexed cost of improvement	NIL
CAPITAL GAIN (LONG TERM) TO BE TAXED IN FY 2020-21	5,75,000

Note 1: The cost inflation index for the FY 2017-18 in which the asset is purchased is 272 and for the FY 2019-20 in which the agreement for re-development is entered into is 289.

Note 2: In the earlier illustration, the date of transfer was 5^th February 2021 and hence indexation was done up to the FY 2020-21; while in this illustration, the date of transfer is the date of agreement of re-development i.e. 1^st January 2020 and indexation is done up to FY 2019-20. Further, the capital gain is taxed only in the FY 2020-21 upon completion of re-development on 5^th February 2021.

EXEMPTION UNDER SECTION 54 IN CASE OF RE-DEVELOPMENT

We have studied above that tax exemption is available to the assessee under section 54 in case the capital gain from residential long term capital asset is reinvested in a residential property and the conditioned mentioned above are adhered to.

Now, in case of re-development, exemption under section 54 can be claimed on the TRANSACTION 2 that takes place i.e. on the transfer of our new share in redeveloped property by the real estate developer. The value of purchase of property in such case shall again be deemed to be the stamp duty value (guideline value) of the share of property received upon re-development.

Thus, effectively, if the conditions of section 54 are fulfilled, there shall be no capital gain since the whole capital gain is reinvested in new residential property and hence, there shall be no tax liability. Solution to our above illustration can also be continued to incorporate this as follows:

PARTICULARS	AMOUNT
CAPITAL GAIN (LONG TERM) TO BE TAXED IN FY 2020-21 as calculated above	5,75,000
LESS: Exemption under section 54 (deemed purchase value Rs.10,00,000/- and construction completed within 3 years)	5,75,000
CAPITAL GAIN (LONG TERM)	NIL

Please note that the exemption under section 54 is available only in case of long term capital gain and is not available for short term capital gain (as also mentioned in the condition 1 supra).

Another important condition of section 54 which we studied above is that the amount of capital gain is to be kept aside in a special account till the construction is complete. Now, in case of re-development, since there is no actual inflow or outflow of money and capital gain is charged on deemed values, how the assessee will deposit the amount in special account is still UNANSWERED by Income Tax.

CONCLUSION

The key points to be kept in mind in case of re-development of any residential house or flat for any layman are as follows:

• It is better if the capital gain is long term (i.e. property undergoes re-development after 24 months of purchase) since exemption can be availed only for long term capital gain under section 54.
• It should be ensured that the real estate developer completes the re-development of the property within 3 years from the date of agreement. Failing this, there shall be no exemption under section 54 and the whole capital gain shall be taxable at a flat rate of 20%.

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