Capital gains are the gains you make on selling or transferring your capital assets at a profit. Capital assets include a wide variety of assets such as property, jewelry, trademarks, shares, debentures, bonds, land, and so much more.
Since capital gains are a part of your income, you are liable to pay income tax on these gains when they add to your other sources of income.
However, the Income Tax Department has excluded certain assets from the definition of capital assets. These are:
- Stock-in-trade, raw materials for business purposes,
- Movable property held for personal uses, excluding jewellery, gold, paintings, etc.
- Specified gold and special bearer bonds
- Specified agricultural land.
This blog will specifically cover capital gains and capital gain taxes related to the sale of property in India.
What are capital assets and capital gains? What are its types?
Capital assets, as per the Income Tax Act, can be any property owned by an individual, such as buildings, jewelry, land, machinery, vehicles, and much more. The gains you make on transferring such assets are known as capital gains.
The concept of capital gains does not hold true in the case of property that is inherited, as selling does not happen here. However, if you wish to inherit the property to sell it in the future, you'd be liable to pay capital gains taxes.
In the case of property, capital gains can be further classified into two broad types;
- Short-term capital gains: These refer to the gains made when you sell your property after holding it for a period not exceeding 36 months. However, in the case of immovable property such as buildings, land, property, etc., the holding period must not exceed 24 months to be considered STCGs.
- Long-term capital gains: These refer to the gains you make on selling your property after holding it for a period exceeding 24 or 36 months. The income you earn on selling will be considered as LTCGs.
How to calculate capital gains on the property?
Before learning the formulas to calculate short-term and long-term capital gains on property, it is important to learn the basic terms.
Full consideration value: It refers to the amount the seller of the property/asset receives on selling the same.
Cost of acquisition: It is the amount you pay while purchasing the asset/property.
Cost of improvement: It is the expense you incur on improving the asset/property, purchasing or owning it.
Cost of transfer: It refers to the amount you bear while selling the asset, such as brokerage or commission, etc.
Indexed cost of acquisition: When an asset is held over the years, inflation has to be adjusted to calculate the fair value of the asset. It is done by using the CII (Cost Inflation Index).
Indexed cost of improvement: It is the amount calculated by: cost of improvement*CII of the year of the acquisition or transfer of asset/CII of the year asset was improved.
Calculation of short-term capital gains on property
Short-term capital gains on property = Full consideration value on the sale of property (-) expenses connected with the sale or transfer of property (e.g.: brokerage, commission, etc). (-) acquisition cost (-) improvement cost (if any)
Calculation of long-term capital gains on property
Long-term capital gains on property = Full consideration value on the sale of property (-) expenses borne on sale or transfer of property(i.e., brokerage, commission, etc.) (-) Indexed acquisition cost of the property (-) indexed improvement cost of the property (if any)
Example
Mr Raj bought land for ₹ 1,00,000 in December 2005 and sold it for Rs 10,10,000 in May 2021. He paid a brokerage of ₹ 10,000 on selling. What will be his tax liability?
It is quite clear that the gains he made fall under the category of "long-term capital gains". Let's calculate his tax liability.
| Full consideration value on the sale of property | 10,10,000 |
| less: expenses borne on sale or transfer of property(eg: brokerage, commission, etc.) | 10,000 |
| Net sales consideration | 10,00,000 |
| less: Indexed acquisition cost of the property | 2,70,940 |
| less: indexed improvement cost of the property | nil |
| long-term capital gains on property | 7,29,060 |
Indexed cost of acquisition: cost of acquisition * CII of the year of transfer/ CII of the year of acquisition
= ₹ 1,00,000 * 317 / 117
= ₹ 2,70,940
CII of 2005-06 is 117, and 2021-22 is 317.
Source: Income tax website
Capital gains tax on property
Capital gains tax for a property depends upon the holding period and the nature of the property being sold.
In the case of movable property:
- For short-term gains: If the movable property is sold after being held for less than 36 months, the tax liability will depend on the taxpayer's income slab rate.
- For long-term gains: If the movable property is sold after being held for more than 36 months, a 20% tax rate will be applicable (plus surcharges and cess as applicable).
In the case of immovable property:
- For short-term capital gains: If the immovable property is sold after being held for less than 24 months, then the gains will be taxed at the taxpayer's income slab rate.
- For long-term capital gains: If the immovable property is sold after being held for more than 24 months, the gains would be taxed at a 20% rate of tax plus cess and surcharge as applicable.
Example
Let's take the same example and calculate the tax liability of Mr Raj, considering that he did not have any other source of income for that particular year.
His tax liability on LTCGs he made on the property would be:
= ₹ 7,29,060 * 20% + 4% health and education cess
= ₹ 1,51,644
Tips to reduce tax liability
There are many strategies to reduce your tax liabilities on the sale of property in India. A few of them are mentioned below:
Section 54
If you sell a property such as land, you can reduce the tax liability or be exempted from paying tax. The strategy is to use the gains towards purchasing or building a new house. However, you can use the exemption if your gains are under ₹ 2 crores.
Section 54EC
If you don't have any plans to build or purchase a new property, you can invest the gains in some specified bonds such as NHAI and/or REC. However, you can only invest up to 50 lakhs. The lock-in period is of five years.
Set off against losses
Another way to reduce your tax liability is to set off long-term capital losses towards long-term capital gains and do the same with short-term capital losses.
Final words
Capital gains on the sale of property attract short-term or long-term tax liabilities. The applicable tax rate depends on the holding period of the property before selling it and the nature of the property, whether it is movable or immovable.
The income tax department has allowed taxpayers to reduce their taxable income or tax liabilities by utilizing various exemptions given in the act. You must consult your financial advisor for better and customized tax planning.