Capital Gains and Tax Relief on Sale of Residential Property

Capital Gains and Tax Relief on Sale of Residential Property

Capital gains arising from the sale of a residential house property in India are classified as either Short-Term Capital Gains (STCG) or Long-Term Capital Gains (LTCG) based on the holding period. If the property is held for 24 months or less, the gains are treated as STCG and taxed at the applicable income slab rates. If held for more than 24 months, the gains qualify as LTCG and are taxed at 20% with indexation or 12.5% without indexation, whichever is more beneficial.

Indexation adjusts the acquisition cost using the Cost Inflation Index (CII) to consider price inflation, reducing taxable gains and tax liability. Indexation benefit is currently available only to resident individuals and HUFs for properties acquired before 23.07.2024 and held for more than 24 months.

Offset Capital Gains Tax by Investing in a Residential House: A Planned Approach

Investing in a residential house property can be a powerful tax-saving strategy when you’ve earned LTCG from the sale of long-term capital assets. The Income Tax Act, 1961 provides two important provisions—Section 54 and Section 54F—that allow exemption if the gains are reinvested in a residential house.

• Section 54 is applicable when a residential house is sold after holding it for over 24 months. Reinvesting the entire LTCG in another residential house—within 1 year before or 2 years after the sale, or within 3 years (in case of constructing new house)—qualifies for full exemption. There is also a once in a lifetime option under Section 54 to buy two residential house properties using the capital gains arising on sale of one residential house property, if the LTCG do not exceed two crore rupees.
• Section 54F applies when any other long-term capital asset (like land, gold, or shares) is sold. Here, the entire net sale consideration (sale proceeds and not just LTCG) must be reinvested in a residential house to claim full exemption.

 Two critical conditions to keep in mind:

• Lock-in Period: The new house must not be sold within 3 years, or the exemption will be revoked and taxed as capital gain in the year of sale.
• Ownership Limit (Section 54F): You must not own more than one other residential house on the date of transfer (apart from the new house).

There are additional conditions relating to reinvestment timelines, CGAS deposits and investment thresholds that must also be complied with. It's advisable to consult a qualified tax advisor at the time of selling a house or planning to invest in a second house property in order to ensure maximum tax efficiency.

With proper planning and timely reinvestment, these provisions offer a legitimate and effective way to reduce capital gains tax.