Friday, 15 April 2016

Best Ways to Save Your Capital Gain Tax

Posted by MyInvestmentsPub
Generally the real estate investments are long term investments. People buy a property and sell at higher prices later. Most of the investors sell their property at a profit. Profits or gains arising from selling of these properties or assets are called “Capital Gains” and are charged to tax under the head “Capital Gains”. However, the amount involved in sale / purchase of a property is usually very high and the Capital Gains Tax is also very high. Many of us do not know how to reduce these Capital Gain Taxes and unnecessarily loosing huge money in the form of taxes. We will see what are all the options available to reduce the Capital Gain Tax and to maximize the savings.

What is Capital Gain Tax:

  1. Capital gain means the profit or gain earned from sale or transfer of capital assets (Property, shares and other capital assets). The taxes imposed by income tax department on capital gain are called as capital gain tax.
  2. If the capital gain is on sale of property asset which is in the possession of seller for less than three years duration then it is short term capital gain (STCG) else it falls in the purview of long term capital gain (LTCG).
  3. Effective tax rates for LTCG are 20% and for STCG as per prevailing income tax slabs.
  4. If you sell the property at a profit in less than three years, then short term capital gains tax shall be applicable. On the other hand if you sell the property after three years, then a capital gains tax of 20 per cent shall apply after indexation.

Traditional Ways to save tax on Capital Gains:

1. Reinvesting in Another Property (Under Section 54):

This is the common traditional way of saving Capital Gain Taxes. You can reinvest your sale proceeds in another residential property. The salient features are as follows:

  • Under Section 54 of the Income Tax Act you are allowed to reduce your long term capital gains to the extent these have been invested in purchasing a new house property. 
  • It should be residential property and not commercial property.
  • You do not have to invest the entire sale receipt, but the amount of capital gains. For example, if you have purchased a property for Rs 10 lakhs in 2000 and sold it in 2016 for Rs 30 lakhs, you need to pay capital gains tax on property on the profit of Rs 20 lakhs and you need to invest this 20 Lakhs to save the Capital Gain tax.
  • 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). Seller also can invest money in specific bond up to limit of Rs 50 Lakhs to save LTCG tax.
  • Seller can also buy a house 1 year prior to selling the house and still can avail the benefit under section 54. The seller has another option, either he can buy another house within two year from sale of property else he can build a house in three years. In these scenarios, he can save the Capital Gain Tax under section 54.
  • If seller failed to buy a property within three years after selling property the whole amount will exposed to LTCG.

2. Invest into Capital Gain Bonds (Under Section 54 EC):

It is also one of the most popular method to save capital gains tax. This bond is a big relief to those people who already has a house and can’t take benefit of section 54. The investment into these bond save the capital gains tax. Salient features are as follows:
  • Under section 54 EC, seller can invest in bonds issued by National Highway Authority of India (NHAI) and Rural Electrification Corporation (REC). You can invest in capital gains bond of NHAI and Capital gains bond of REC through the designated branches of the banks. You can download the form NHAI and REC online. 
  • You can put all of your capital gains into these bond. The money invested into these bonds is exempted from the capital gains tax. However, limit for exemption under section 54 EC is Rs. 50 Lakh.
  • The capital gains bond give annual interest rate of 6%. It is lower than the prevailing fixed deposit rate and almost same as the current Inflation rate.
  • The interest of capital gains bond is taxable but TDS is not applicable.
  • You must invest the capital gains into these bond within 6 month of capital gain realization.
  • The money is invested for 3 years. It remain locked for 3 years.
  • After 3  years, you don’t get any interest. The redemption of capital gains bond has become automatic.
  • You can’t transfer these bonds to anyone. Also these bonds can’t be pledged or sold
  • If the amount invested in bonds is less than the capital gains realized, only proportionate capital gains would be exempt from tax.
  • The bonds are very secure. These bond are AAA rated by the rating agencies.
  • The face value of the bond is 10,000 and the minimum investment should be of Rs 20,000.
  • The investment into the capital gains bond can’t go beyond 50 lakhs in a financial year.
  • Bonds can be held in Demat /Physical Form

3. Opening Capital Gains Account Scheme:

There is another method to save capital gains tax. This scheme is for those people who can’t invest in a new residential property before e-filing income tax return. It gives relief to the taxpayer for time being. You can put money in this scheme for 3 year. During this period you can use the capital gains for purchasing or constructing a new residential house. Following are the features of capital gain account scheme.

  • The deposit should be made before filing income tax return. The investment in capital gain account scheme should be mentioned in the income tax return.
  • The account can be opened only with specified banks. Every scheduled banks open capital gains account. You can open account from any branch. The cooperative bank and regional bank are not eligible for this account.
  • The interest on capital gains account is taxable. The TDS is deducted as per the provisions.
  • The deposit can be made in lump sum or in installments at any time on or before the due date for filing the return of income. For example, assume that you have sold a property on 15 January 2016, and are not able to use the gains by 31 July 2016. In such a situation, you should open a CGAS account and deposit the money in it by 31 July 2016. You can deposit in cash, by cheque or by draft.
  • There are two types of accounts—account A and account B
  • Account A is  similar to a savings account. You can put or withdraw money as per your requirements. The interest rate of Account A is similar to the saving account. It is 4%.
  • Account B is similar to the fixed deposit. You put money for the specified period. The interest rate of account B is comparable to the fixed deposits. You can transfer all of your money from type A account to type B account or vice versa.
  • If you plan to buy a property after a year, choose account B. But if you plan to build a house soon, and would need money periodically, choose account A.
  • Money withdrawn has to be used within 2 months. The interest rate is fixed periodically by the Reserve bank of India.
  • The amount deposited in capital gains account can’t be used as mortgage for any loan.

New options to Save Capital Gain Tax:

1. Investing into a Start-Up company (Under Section 54GB):

The recent Budget has introduced two new Investment options to save Capital Gain Tax. Investing into a Start-up company is one such new option under section 54 GB. The salient features are as follows:
  • Individuals will now be able to save tax on capital gains by investing in start-ups directly or indirectly.
  • Under Section 54GB, if a person reinvests the long term-capital gains earned from the sale of a residential property in an eligible start-up, then again he will become eligible for exemption on those gains.
  • The individual investor should hold more than 50 per cent share in the start-up. He should be the majority shareholder in the entity. Small, minority and passive investments in start-ups will not make you eligible for tax benefit, and the amount invested by you must be effectively deployed by the start-up.
  • The start-up should have utilized the amount to purchase new assets before the due date for filing tax return.
  • The failure rate among start-ups is very high, hence it is quite possible that you could end up losing the capital you have invested. 
  • With a higher degree of risk, since your capital will be invested in a start-up, there is always a chance that you may receive a bigger payout a few years down the line as well as there is an equally high risk of the value of your investment getting eroded.

2. Investing in a Fund-of-Funds (Under Section 54EE):

This is a new option given in the recent Budget. Under Section 54EE, investors may invest in a fund-of-funds, which will in turn invest in startups. The salient features are as follows:
  • Under Section 54EE, investors may invest in a fund-of-funds, which will in turn invest in startups. The government plans to raise Rs 2,500 crore annually for four years (Rs 10,000 crore altogether) in these funds.
  • If investors reinvest their capital gains in such an approved fund, they will be exempted from paying tax on those gains. 
  • This investment avenue comes with a couple of pre-conditions. The amount you may invest shouldn't exceed Rs 50 lakh.
  • The investment will carry a three-year lock-in and premature withdrawal will result in the tax benefits being reversed.

My Suggestions to the Investors:

  1. Different individuals have different levels of risk tolerance. A very conservative investor who does not want to put his capital at risk should opt for the existing capital gains tax saving bonds.
  2. Conservative investors with a longer term outlook may consider the option of buying a property. 
  3. The good thing is that now you have a bouquet of products available carrying varying degrees of risk and return. Closely examine your level of risk tolerance and choose an option that suits your risk appetite.
  4. The two new options are completely different because they are akin to equity investments, but with a higher degree of risk, since your capital will be invested in a start-up or equity.
  5. The probability of loss is even higher when you invest in a start-up yourself, instead of via the fund-of-funds route. The latter at least offers the benefit of diversification. When you invest the entire amount in a single venture, you could lose all of it if the venture fails.
  6. Those with a moderate appetite for risk may opt for the fund-of-funds route, which provides some degree of safety via diversification.
  7. At the high end of the risk spectrum is the option to take a majority stake in a single start-up. Here, the downside risk is huge, but the payoff can be equally spectacular if the venture succeeds. 


There are couple of options available for Investors to save their Capital Gain Tax. For conservative investors with low risk appetite should go with the traditional approach of investments. For Investors with high risk appetite can choose the two new options which are recently introduced.


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