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Your home and capital gains
June 23, 2005
number of readers have been sending us queries on capital gains related to the selling of their home.
A typical query would be that they booked an apartment a few years ago for which they took a loan. Now that they are earning more, they would like to sell it for a bigger apartment.
The first question that comes to mind: what about capital gains? Here are some of the most frequently asked questions on capital gains.
1. Do I have to pay capital gains tax if I sell my home?
When you sell any asset you own (house, land, shares, mutual fund units, gold, debentures, bonds) and make a profit, it is known as capital gain. The tax you pay on this profit is called the capital gains tax.
If you make a loss (you sell at a lower price than what you bought it for), you incur a capital loss.
House property is a capital asset. Its sale attracts capital gain or loss. Depending on how long you owned the house before you sold it, the money you make on the sale would be long-term or short-term capital gain or loss.
2. What do you mean by short-term capital asset and long-term capital asset?
If you owned the house an asset for less than three years (36 months) before selling it, then it is considered a short-term capital asset.
If you sell it after this time, it is a long-term capital asset.
3. Why is long-term capital gain more beneficial than short-term capital gain?
Short-term capital gain is added to your total income. Depending on which tax bracket you fall under, you will be taxed.
In the case of long-term capital gain, you will get the benefit of indexation. Indexation is the process by which inflation is taken into account so that the amount you end up paying as tax is reduced.
The tax on long-term capital gain is much lower than that on short-term capital gain.
4. How is indexation calculated?
Indexation is calculated by taking into account the Cost Inflation Index.
These indices are fixed and declared by the central government every year (see table below).
5. How do I calculate capital gain?
Let's say Mr M purchased a house for Rs 250,000 on June 20, 1996, and sold it on January 20, 2005, for Rs 450,000. Since he sold the house 36 months after he bought it, the capital gain will be long term.
In order to find out your capital gain, you first calculate the Cost Inflation Index. In this case:
Cost inflation index = Index of the year it was sold divided by the index of the year it was bought
= 2004-05 index / 1996-97 index
= 480/ 305 = 1.57377
You then you calculate the Indexed Cost of Acquisition
= Buying cost x Cost Inflation Index
= Rs 250,000 x 1.57377
= Rs 393,443
Now, you need to calculate (in this case) the Long Term Capital Gain
= Selling price - Indexed cost
= Rs 450,000 - Rs 393,443
= Rs 56,547
Tax payable will be 20% of Rs 56,547 ie Rs 11,310 (plus surcharge of 10%, if applicable).
6. Can I claim the expenses like brokerage, registration fees, stamp duty and other charges arising out of sale of my house property from the profit that I make on the sale?
Yes. These expenses are allowed on the sale of house property.
7. Can I avoid paying capital gains tax by investing anywhere?
You have no such option in the case of short-term capital gain.
However you can save on long-term capital gains as follows.
a) Buy a new house (Section 54 of the Income Tax Act)
You will have to do so within a year of selling the house or within two years from the date of transfer. If you are constructing a residential property, you will have to do so within three years of the date of sale.
The exemption amount, in this case, is restricted to the cost of the new house property.
In case the amount of capital gain is less than the cost of the new house property, the entire amount of capital gain is exempt from tax.
On the other hand, if the amount of capital gain is more than the cost of the new house property, the difference between the amount of capital gain and the cost of the new house property will be taxed as long-term capital gains.
Let's say Mr Y bought a house on March 1, 1996, for Rs 100,000 and sold it on March 12, 2001, for Rs 300,000.
Let's assume he invests Rs 100,000 in a new house.
The capital gain after indexation would be Rs 155,516.
Capital gain - amount invested = Rs 155,516 - Rs 100,000 = Rs 55,516
Since the capital gain is more than the cost of new house, the tax will be Rs 11,103 (20% of Rs 55,516)
b) Investments in bonds (Section 54 EC of the Income Tax Act)
You can buy bonds issued by the Rural Electrification Corporation, National Highways Authority of India and National Bank of Agricultural and Rural Development.
8. Is there any due date for the investments above?
Yes. You should make the investments (either buy a new house or purchase the bonds) within six months from the date of sale.
9. What if I don't want to buy the bonds but purchase property later?
Let's say you don't want to invest your money in these bonds but intend to use it to purchase property at a later date. If you still want a deduction on the tax you will have to pay on your capital gain, you can opt for the Capital Gains Scheme of Deposit Account.
You will have to open a such an account in any branch of a public sector bank in accordance with the Capital Gains Account 1988.
The amount deposited in the CGSDA is considered utilised for the purchase/ construction of the new house.
However, if the amount you have deposited is not used for buying a new house within a period of three years, then that amount shall be treated as long-term capital gain of the previous year.
Let's say Mr X sells a residential house property on January 5, 2002, and makes a capital gain of Rs 5,00,000. He wants to purchase another house property from the money he has made by selling this property.
He is unable to purchase the new house before July 31, 2002, by when he has to file his tax returns for the year ended March 31, 2002. So he invests the money he has made in the scheme of deposit account and still gets exemption from capital gains.
Mr X, however, utilises only Rs 400,000 within this stipulated period (three years from the date of sale of the old house).
The remaining Rs 100,000 is treated as long-term capital gain and will be taxed accordingly after three years have passed since the date of sale (which, in this case, is January 5, 2002).
10. What if I sell and make a loss. Is there any such concept as capital loss?
The capital loss can be carried forward for eight assessment years. However, long-term capital loss can be set off only against long-term capital gain.
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