How to save Capital Gains Tax on Selling a House?

We are all paying income taxes and know that as the name suggests, this is a tax levied on income. However, tax levied on sale of capital assets, that is, immovable property etc is called capital gains tax. Real estate is probably the most dynamic investment one can make.

With property prices soaring at a rate of nearly 20% a year, it is very important to be well informed and capable of understanding and planning for taxes on sale of property. In this article, I will attempt to touch upon the provisions in Income tax act relating to sale of house property.

My friend Malini did all her math meticulously to arrive at the best price to sell her house. She wanted to generate funds to plough into her dream home and she knew exactly what she wanted. However, she was shocked when she realized that she had to shell out nearly 20% of her money towards capital gains taxes.

Understanding the Elements – Capital Gains Tax

The elements in any sale are quite simple. They are Sale price, cost price and profit / loss. Similarly, the elements in sale of house property are also Sale price, Cost of acquisition and Profit or Loss on sale of property. So, the basic calculation of sale will be as under:

Sale Consideration	xx
Less:
Cost of acquisition	xx
Profit / Loss	xx

Most of us also pay brokerage or incur some other cost for selling the property. The provisions of the law enable us to reduce this amount also from the Sale price to calculate profit / loss. This is called the Cost of transfer.

Now, when we talk about house, it also entails a lot of maintenance. Sometimes, you might have fixed a leaking roof, or done some painting, or even refurbished the house. This involves a lot of money and the good news is that the law also gives you respite for these costs. This is called the Cost of Improvement.

I bought my house 10 years back for a measly price of 15 lacs. However, if I were to sell it today, it will fetch me 40 lacs. But, isn’t it a bit unfair if you ask me to pay taxes for the inflation factor prevailing in the market?

Honestly, if I were to buy a kilogram of rice 10 years back, it cost me Rs. 28, but today it costs me Rs. 39! If I were to assume that as the standard assumption, the inflated cost of my house would be around 21 lacs. So, why should I pay taxes for this?

To address this problem, the Income tax department releases a cost inflation index every year. This index can be used to calculate the inflated cost of purchase / acquisition / improvement. The indexed cost of acquisition can be calculated as under:

Indexed Cost of acquisition = Cost of acquisition * Index of Current Year / Index of year of acquisition

Similarly, the indexed cost of improvement can be calculated as under:

Indexed Cost of improvement = Cost of improvement * Index of Current Year / Index of year of improvement

An excerpt of the chart for cost inflation index is given below:

Now, you might ask me the most obvious question, what happens to property acquired before 1981. The market price as of 1981 is taken into consideration for calculating the indexed cost of acquisition.

Now, that we understand all the elements in detail, let us now attempt to see how profit or loss is calculated.

Sale Consideration	xx
Less:
Cost of transfer	xx
Indexed cost of acquisition	xx
Indexed cost of improvement	xx
Profit/Loss	xx

Other savings

We have now seen all the important elements of arriving at the long term capital gains / loss. But, the provisions of the Income tax act further offer savings in case of certain investments. These are as follows:

• Investing in a new house – To be purchased within 1 year of sale or to be constructed within 3 years of sale
• Investing in NABARD bonds – To be purchased within 6 months of sale.

When I purchased my house, it took me a good 1 year before I got the papers vetted by the lawyer, arranged for the money and finally finished the deal. For some people it may take still longer. In such cases, you can invest the money in a capital gains account scheme and notify the same to the Income tax department. This money can then be used for such purchase within the stipulated period.

The amount of investment is deducted from the profit as calculated above. Only the balance of profit will be subjected to long term capital gains tax of 20%.

Conclusion

So, if you need to sell your house to invest elsewhere, don’t fret. Now that you are all informed, you can minimize the impact of Long term capital gains and plan to factor the capital gains in the sale consideration so that you do not lose on much needed capital. The benefit is that the tax on a long term capital gain is taxed only at a 20 percent rate after indexation.

This brings down the amount of tax payable considerably as compared to the short-term capital gain tax. Apart from this, you might be able to avoid paying tax on the sale of the house, and you also have options for reducing the tax burden following the sale of real estate.

To save long term capital gain the seller has to buy a house property within two years of sale of capital asset or construct a house within three years. If  seller is not able to identify a property he/she can open a capital gain accounting scheme’s special account and park the money until he finds the property (with limit of 3 years).