Short term Vs Long term assets
As per the Act, a house is a short-term capital asset for up to two years from the time it is acquired and a long-term asset thereafter. A short term or long term capital gain is accordingly calculated by deducting the following from its sale price:
- Cost of acquisition i.e. cost at which the house was purchased or constructed and includes any related cost like stamp duty or registration charges.
- Cost of sale. For example agent commission, legal costs, etc.
- Cost of improvement i.e. repairs and renovation expenses.
Let’s use an example of Vipin, who acquired a house for Rs 15 lakh and spent an additional Rs 2 lakh on house repairs and renovation. If she sells the house at a price of say Rs 50 lakh and presuming this is a short term capital asset, then Bharati’s short term capital gain would be calculated as follows:
Sale consideration: Rs. 50 lakh
Less: Cost of acquisition: Rs. 15 lakh
Less: Cost of improvement: Rs. 2 lakh
Short Term capital gain: Rs. 33 lakh
Long-term assets are adjusted for inflation. This is called ‘indexation’ and it has a significant impact on the capital gain. In our example, if we presume Bharati acquired and renovated her house in the year 2005-06, and later sold in the year 2020-21, her long term capital gain would be calculated as follows:
Sale consideration: Rs 50 lakh
Less :*Indexed cost of acquisition: Rs 38.59 lakh
Less: *Indexed cost of improvement: Rs 5.15 lakh
Long-term capital gain: Rs 6.26 lakh
*Indexed cost = Actual Cost x Cost of inflation index(CII) in the year of sale ÷ CII in the year of spend.
The CII for FY 2020-21 is 301 and CII for FY 2005-06 was 117 : (Also check: Cost Inflation Index Table up to Assessment Year 2021-22)
Short-term capital gain is clubbed with other heads of income and taxed as per slab rates. Whereas, a long-term capital gain is taxed separately at the rate of 20 percent. Thus, a short-term capital gain is advantageous if the total taxable income is included in the lowest tax slab.
Barring this, a long-term capital gain is usually preferred because apart from indexation, there are benefits by way of exemptions too.
Exemption under section 54
An individual or Hindu Undivided Family (HUF) can avail an exemption on the entire capital gain if it is invested into a new house :
- Purchased one year prior to sale OR
- Purchased within two years after sale OR
- Constructed within three years after-sale
Investment can be in up to two houses provided the gains do not exceed Rs 2 crore. Also, splitting the capital gains to invest in two houses is an option that can be exercised only once in a lifetime. Until the funds are so utilized for the new house, they must be deposited in a ‘capital gains account scheme’ with a bank.
Exemption under section 54EC
Unlike section 54 which applies only to individuals, benefit under section 54EC is available to all persons including companies or partnership firms. For claiming exemption, a taxpayer must deposit the gain (subject to a maximum of Rs. 50 lakhs) in any of the five-year bonds issued by:
- National Highways Authority of India(NHAI)
- Rural electrification Corporation (REC)
- Power Finance Corporation (PFC)
- Indian Railway Finance Corporation (IRFC)
Or any other bond which may be notified by the central government
It must be noted that the amount to be reinvested under section 54 and section 54EC, is the amount of gain and not the entire sale value. Thus, a portion of sale consideration is available as free funds in the hands of the seller.
Caution: Exemption can be revoked
If the requirements of sections 54 and 54EC do not comply, gains that were exempt would be taxed in the year of violation. Accordingly, exemptions would be taxable later if:
- Money deposited in Capital Gains accounts scheme is withdrawn for purposes other than acquiring a house,
- Money in the account remains unutilized at the end of three years,
- A new house that was acquired using capital gains is sold within three years from its acquisition.
- Within five years of deposit, bonds specified under section 54EC are redeemed or used as security to avail a loan.
Double benefits are avoided:
Investment in specified bonds normally qualifies for deduction under section 80C. When an investment is made for the purpose of benefit under section 54EC, no deduction for the same investment is allowable under section 80C.