How to save Income tax on sale of residential property?

Many taxpayers are not aware the provision of the income tax act on how to save the tax on the sale of residential property.  They earn profits on the sale of residential property and pay the taxes. They can save the tax. I have brief the methods from which the taxpayers can save the tax.

Tax liability on sale of house property

Long Term Capital Gain or Short Term Capital Gain

The profit comes from the sale of property is called capital gain. When property is sold after 24 months by holding then profit will be called long term capital gain otherwise short term capital gain. Exemption from tax is allowed only from long term capital gain. Long term capital gain are computed by deducting the indexed cost of the house from its net sale price. Deductions under section 80C, 80D, 80G etc. are not available in respect of long term capital gain.

Applicable Tax Rate

Long term capital gain is taxable at a flat rate of 20%+surcharge (applicable if net income exceeds Rs. 50 lakh) + health and education cess (4%). The amount of taxable income is computed after deducting various deductions like payment for life insurance, mediclaim, PPF or bank interest income etc.

Exemption Limit

No exemption limit is provided in case of capital gain. However, in the case of a resident individual or HUF, the benefit of exemption limit is available, if taxable income minus long term capital gain is less than exemption limit. Exemption limit for resident individual or HUF is Rs. 2, 50,000. For senior citizen (age 60 years or above but less than 80 years) the exemption limit is Rs. 3, 00,000. For super senior citizen (age 80 years or above) the exemption limit is Rs. 5, 00,000.

For Example:

Mr. A (30 years) is a resident individual. For the assessment year 2020-21, he has the following incomes-

In this case, exemption limit available for Mr. A is Rs. 2, 50,000. Taxable income minus long term capital gain is Rs. 2, 47,000. It is less than exemption limit. Consequently, from the long term capital gain the following shall be deducted:

Exemption limit- (Net Income – Long term capital gain)

2, 50,000 – (18, 47,000 – 16, 00,000) = 3,000

Long term capital gain chargeable to tax will be Rs. 15, 97,000 (Rs. 16, 00,000 – Rs. 3,000).

Here are two methods of saving the tax on sale of house property 

First Method – Purchase another residential house (Sec. 54)

Assessee can avail this method of exemption by investing the capital gain amount in purchasing another residential house. For availing exemption, house can be purchased within a period of one year before the transfer or within 2 years after the date of transfer. If the taxpayer invests the whole amount of capital gain in purchasing the house then the entire amount of capital gain is exempt from tax.

On the other hand, if the amount of capital gain is greater than the cost of the new house, the difference between the amount of capital gains and the cost of the new house is chargeable to tax as capital gain.

For Example: Mr. A owns a residential house in Delhi since 1988. The house is sold by him on 25 May, 2019 for Rs. 1, 25, 00,000. Cost of acquisition of the house is Rs. 4, 18,934. On 16 July, 2020 he purchased a house of Rs. 62 lakh. Calculate the amount of capital gain chargeable to tax.

Solution : Calculation of the capital gain:

Assessment year 2020-21

Exemption also available in case of house construction         

Assessee can also claim exemption on construction of the house. Construction of the house should be completed within 3 years from the date of transfer. Construction may be commenced even before the transfer of the house. In the case of compulsory acquisition, the limit of 1 year, 2 years or 3 years is applicable from the date of receipt of compensation.

The house property so purchased or constructed has not been transferred within a period of 3 years from the date of purchase or construction.

Exemption available for one house only

This exemption is available only in respect of investment in one residential house in India. However, from the assessment year 2020-21, the assessee can invest in two houses and claim exemption if the amount of capital gain does not exceed Rs. 2 cr. Assessee can exercised this option only once in a lifetime.

Cost of the new house

The cost of the new house shall include the amount of the brokerage, stamp duty, registration charges and transfer charges and same will be eligible for claiming exemption under section 54 of Income tax act.

Capital gain deposit scheme

Assessee have to utilize the amount of taxable capital gain for buying a house or for construction before the due date of filing of income tax return. If the assessee are not able to utilize full amount of capital gain, the unused amount has to be deposited with a bank under Capital Gains Accounts Scheme. The amount already utilized for purchase or construction of the new house together with the amount deposited in bank shall be deemed to be amount invested in new house for the purpose of exemption.

Assessee should be utilized the deposited amount for purchasing or construction the new house within time mentioned in act. If the assessee fails to utilize the amount deposited in bank within the time period, then such unused amount shall be treated as long term capital gain and taxable.

Consequences if the new house is transferred within 3 years

If the new house is transferred within a period of 3 years from the date of its purchase or construction, the amount of capital gains arising therefrom, together with the amount of capital gains exempted earlier, will be chargeable to tax in the year of sale of the new house property.

Second Method- Investment in specified bonds (Sec. 54EC)

The second option to save tax on long term capital gain is investing the capital gains in specified bonds. These bonds should be issued by the National Highway Authority of India (NHAI), Rural Electrification Corporation Limited (REC) etc.

Investment in bonds should be done within 6 months from the date of transfer of the house property.

Tenure of the specified bonds

The bonds have a uniform tenure of five years. If the assessee transferred the bonds or converted into money or taken any loan against such bonds within 5 years from the date of their acquisition then the amount of capital gain arising from the house property which was not charged to tax, will be deemed to be the income of the previous year in which bonds are transferred etc.

Amount of Exemption

Amount of exemption under section 54EC is lower of the following two amounts:

1. Amount of capital gains generated on transfer of house property
2. Amount invested in specified bonds

Assess can invest maximum Rs. 50 lakh for any previous year in specified bonds.

The cost of the specified bonds shall not be eligible for deduction under section 80C.

Treatment of interest on specified bonds

The interest received on these bonds is fully taxable in your hands but the maturity proceeds of the bonds are fully tax-free.

Both exemption simultaneously

Assessee can claim both exemption in respect of sale of the same house.