How to Calculate Capital Gains Tax on Sale of Residential Property?

‘Capital Gains’ can be defined as the profits or gains arising from the transfer of capital assets. These are chargeable as the income of the financial year in which the sale or transfer takes place. Residential house property is a capital asset for income tax purposes in this instance. Any tax paid on the profit or gains arising on the transfer shall be referred to as ‘Capital Gain tax’.

DETERMINATION OF CAPITAL GAINS FROM SALE OF PROPERTY IN INDIA:

Capital Gains in India are of two types as per the Income Tax Act, 1961:

a. SHORT-TERM CAPITAL GAINS

A short-term capital asset means a capital asset that is held for a period of 36 months or less prior to the date of its transfer. However, an immovable property, being land, building or both shall be recognized as a short-term capital asset if it is held for a period of 24 months or less prior to the date of its transfer (effective from FY 2017-18). Profit or gain arising from short-term capital assets shall be termed as short-term capital gains.

b. LONG-TERM CAPITAL GAINS

A capital asset that is held for a period of more than 36 months prior to the date of its transfer treated as a Long-term capital asset. However, as mentioned under short-term capital gains, in case transfer of land, building or both after holding the asset for a period of more than 24 months, it shall be recognized as a long-term capital asset. Profit or gain arising from long-term capital assets shall be termed as long-term capital gains.

Hence, capital gains are computed based on the period of holding of the asset. The period of holding starts from the date of acquisition of the asset. In case an asset is acquired by way of gift, will, succession or inheritance, the period of holding shall also include the period for which the asset has been held by the previous owner for determination of long-term or short-term capital gains.

CALCULATION OF CAPITAL GAINS:

The income chargeable under the head ‘Capital Gains’ shall be computed based on the full value of the consideration received or receivable by the seller on the transfer of his residential property. Capital gains are chargeable to tax in the year of transfer, even if no consideration has been received in that year. The following items shall be deducted from the full-value consideration for computing capital gains:

• Expense incurred wholly and exclusively in respect to the transfer;
• The cost of acquisition; and
• The cost of improvement

Expense incurred wholly and exclusively in respect to the transfer are the expenses which were incurred for transfer of property to take place. Here, the following expenses can be regarded as expenses incurred for transfer:

• Brokerage or commission paid for securing a purchaser
• Cost of stamp paper
• Traveling expenses in connection with the transfer
• Where property had been inherited, expenditure incurred for the procedures associated with the will and inheritance, obtaining succession certificate, and cost for the executor are also allowed.

NOTE: The method of computation of capital gains differ for Short-term capital asset and Long-term capital asset.

COMPUTATION FOR SHORT-TERM CAPITAL GAINS:

Short-term capital gains are computed if the period of holding is 24 months or less prior to the date of transfer. It is ascertained as Full value consideration less expenses incurred exclusively for such transfer less cost of acquisition less cost of the improvement.

For example, Mrs. Sasha purchased a residential building for Rs.40,00,000 on January 11th, 2019. She sold the property for Rs.58,00,000 on October 12^th, 2020. She has incurred brokerage costs amounting to Rs.1,20,000 at the time of transfer. An improvement to the property amounting to Rs.2,50,000 was made during the period.

Now, the period of holding the asset is less than two years from the date of acquisition. So, it shall be treated as a short-term capital asset. Calculation of the short term capital gains are as follows:

Therefore the amount of short-term capital gains in the above example amounts to Rs.14,30,000 which needs to recognized as an income under the head ‘Short-term Capital Gains’. This shall be chargeable to tax in the financial year 2020-21.

COMPUTATION FOR LONG-TERM CAPITAL GAINS:

Long-term capital gains are computed if the period of holding is more than 24 months prior to the date of transfer of the residential property. It is ascertained as Full value consideration less expenses incurred exclusively for such transfer less Indexed cost of acquisition less Indexed cost of the improvement less exemption that can be deducted from gross long term capital gain.

Cost of acquisition and improvement is indexed by applying CII (cost inflation index) for the purpose of computing the Long-term capital gain in case of sale of immovable property. This is done to adjust for inflation over the years of holding of the asset. CII is a very crucial factor in determining the indexed cost of acquisition and improvement and the Government declares this index every year.

Calculation of Indexed Cost:

Indexed cost of acquisition is computed as Cost of acquisition / (Cost inflation index (CII) for the year in which the asset was first held by the seller, or 2001-02, whichever is later) X cost inflation index for the year in which the asset is transferred.

Indexed cost of the improvement is computed as Cost of improvement X Cost inflation index of the year in which the asset is transferred / Cost inflation index of the year in which improvement has taken place. Refer here for currently applicable CII rates.

For example, Mr. Karthik had purchased a residential property during the FY 2004-05 amounting to Rs.24,00,000. He had made major improvements in the building during the FY 2006-07 for Rs.15,00,000. Later, in the FY 2020-21, he had sold the asset for Rs.1,50,00,000. He has also incurred a brokerage cost of Rs. 2,00,000 for the transfer.

Now, the period of holding the asset is more than two years from the date of acquisition. So, it shall be treated as a long-term capital asset. Calculation of the long-term capital gains are as follows:

Working Notes:

Indexed cost of acquisition  = Cost of acquisition of the property X Cost inflation index for the year of taxation (FY 2020-21) / Cost Inflation index as on the year of acquisition (FY 2004-05)

= Rs.24,00,000 X 301 / 113

= Rs.63,92,920

Indexed cost of improvement = Cost of improvement of the property X Cost inflation index for the year of taxation (FY 2020-21) / Cost Inflation index as on the year of improvement (FY 2006-07)

  =Rs.15,00,000 X 301 / 122

  =Rs.37,00,820

Therefore the amount of long-term capital gains in the above example amounts to Rs.47,06,260 which needs to recognized as an income under the head ‘Long-term Capital Gains’. This shall be chargeable to tax in the financial year 2020-21.

EXEMPTIONS ON CAPITAL GAINS RELATED TO SALE OF PROPERTY:

In case of Long term capital gain, a significant amount of money shall be paid as tax. This can be reduced by taking the benefit of exemptions provided by the Income Tax department on capital gains where profit or gain from the sale is reinvested into buying another asset.

The following are the exemption in respect of Capital gains related to sale of residential property:

SECTION 54: CAPITAL GAINS ON SALE OF RESIDENTIAL HOUSE

• Section 54 of the Income Tax Act is eligible for capital gains arising to an Individual or HUF from transfer of residential house (land, building or both). This section shall be applicable when asset transferred is a long-term capital asset.
• CONDITIONS TO BE FULFILLED:
  • Where the amount of capital gains computed exceeds Rs. 2 crore, one residential house in India should be –
    • purchased within one year before or two years after the transfer (or)
    • constructed with a period of three years from the date of transfer
  • Where the amount of capital gains computed does not exceed Rs. 2 crore, the eligible assessee, may at his discretion –
    • purchase two residential houses in India within a period of one year before or two years after the date of transfer (or)
    • construct two residential houses in India within a period of three years from the date of transfer.
  • The new residential asset acquired or constructed should not be transferred before completion of three years from the date of acquisition or construction, respectively.
• The option to claim exemption for the purchase or construction of the two residential house in India can be made once in a lifetime.
• The amount of exemption under section 54 shall be computed as below:
  • If the cost of new residential house or houses is greater than or equal to the long-term capital gains computed, then the entire long-term capital gains is exempt.
  • If the cost of new residential house or houses is less than the long-term capital gains computed, then the long-term capital gains to the extent of cost of new residential house is exempt.
• If in case the new asset is transferred before three years from the date of acquisition or construction, then, the cost of the asset will be reduced by the capital gains exempted earlier for computing the capital gains and the amount of Capital Gains exempted value shall be chargeable to tax under the head long-term capital gains in the year of such violation.
• If the above mentioned investment in residential house(s) is not made before the date of filing of income tax return (or) on or before due date of filing the income tax return, whichever is earlier, then the capital gains needs to be deposited under the Capital Gains deposit scheme. The amount deposited under this scheme can be withdrawn for utilization for the specified purchases under the scheme.
• If the amount deposited is not utilized for the specified purpose within the specified time, then the unutilized amount shall be treated as capital gain for the year in which the specified time expires.

SECTION 54EC: CAPITAL GAINS NOT CHARGEABLE ON INVESTMENT IN CERTAIN BONDS

• Section 54EC of the Income Tax Act is eligible for capital gains arising to any assessee from transfer of long-term capital asset residential house (land, building or both). This section shall also be applicable on sale of a depreciable asset being building held for a period more than 24 months.
• CONDITIONS TO BE FULFILLED:
  • The amount of capital gains arising from the transfer should be invested in long-term specified asset within a period of six months from the date of transfer.
  • Long-term specified asset means specified bonds, redeemable after 5 years, issued on or after 01.04.2018 by the National Highways Authority of India (NHAI) or the Rural Electrification Corporation Limited (RECL) or any other bond notified by the Central Government in this behalf.
  • The amount invested should not be transferred or converted or used for availing loan or advance on the security of such bonds for a period of five years from the date of acquisition of such bonds.
• The maximum amount of investment which can be made under the specified asset during the year in which the long-term capital residential house is transferred and in subsequent year cannot exceed Rs.50,00,000 in total.
• The amount of exemption under section 54EC shall be computed as the capital gains or amount invested in specified bonds, whichever is lower.
• In case of transfer or conversion of such bonds for sale or availing loan or advance on security of such bonds before the expiry of five years, the amount of capital gains which was exempted earlier shall be taxed as long-term capital gain in the year in which the violation has taken place.

APPLICABLE TAX RATE FOR CAPITAL GAINS ON RESIDENTIAL PROPERTY:

The applicable tax rate shall be applied on the net short-term capital gains or long-term capital gains computed after deduction of exemption under the above-mentioned provisions of the Income Tax act. The tax rates are –

• Short-term capital asset shall be taxable in the normal income tax slab rate of the assessee
• Long-term capital asset shall be taxable at 20% with indexation

This article has been written by Parkave B who is a third year internship student at V Ramaratnam and Company, Chartered Accountants. To know more about Capital Gains Tax, you may reach out to V Ramaratnam and Company, Tax Consultants in Chennai. We offer you expertise in Capital Gains Tax Services.