Capital Gains arise when a residential property is sold for a value higher than the cost of purchase or construction. There are two categories of capital gains. Short-term capital gains arise if a house is sold within 36 months from date of purchase. If a house is sold after 36 months from date of purchase or construction, the surplus will be taxed as long-term capital gains.
The distinction between short-term and long-term capital gains is important, as the rates of tax are different. Short-term capital gains is added to other heads of income like salary, income for business or profession, and other incomes like interest etc. and taxed at the relevant slab rate. In the case of long-term capital gains, the tax is a flat rate of 20 percent on the capital gains amount, plus applicable surcharge.
Capital losses can be set off against other heads of income, except long-term capital losses that can be set off only against long-term capital gains.
COMPUTING CAPITAL GAINS
Capital gains is computed by deducting from the amount of sale consideration the following:
- Cost of acquisition of the property, including cost of any improvements made or any capital expenditure for modifications and/or renovation that is permanent in nature.
- Adjustment factor for indexation, and
- Costs or expenses relating to the sale of the property e.g. brokerage, commission etc.
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INDEXATION
Indexation is a deduction allowed to adjust for inflation during the period of property ownership. Indexation helps to tax real profits and not inflationary profits. The government publishes the annual cost inflation index every year for the current year 2004-05 the index is 480 (base year 1981-82 – 100)
The indexed cost if calculated by multiplying the asset cost with the index of the year of sale and dividing the result with the index of the year of purchase or construction
The Income Tax Act has two situations where capital gains tax on sale of residential property need not be paid
Situation 1: Investment in another residential property (Section 54)
If the full amount of capital gain is spent on purchasing or constructing a new property, there will be no tax liability. If the amount spent on the new property is less than the capital gains amount, then the difference between the cost of new property and the capital gains amount will be taxed. There are time limits for purchase and sale prescribed in the section which should be compiled with. If the new property is not acquired immediately in the same financial year or within the date for filing the return of income, then the capital gains amount should be deposited in a Capital Gains Deposit Account Scheme with a nationalized bank.
Situation 2: Investment in financial assets (Section 54 EC)
If the full amount of capital gain is invested in specific bonds there will be no tax liability. Presently, bonds issued by NABARD, Rural Electrification Corporation, National Highways Authority of India, National Housing Bank, and Small Industries Bank of India is notified for this purpose. The investment should be made within six months from date of sale and there is a lock-in period of three years.
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AN EXAMPLE OF CALCULATION OF CAPITAL GAINS ON SALE OF RESIDENTIAL PROPERTY
Case:
| Purchase of house in July 1998 |
|
Rs. 7,50,000 |
| Sale of house in May 2004 |
|
Rs. 11,20,000 |
| Brokerage paid for arranging Sale |
|
Rs. 10,000 |
| |
|
|
| Calculation of capital gains: |
|
|
| Cost inflation index for 1998-99 |
|
351 |
| Cost inflation index for 2004-05 |
|
480 |
| |
|
|
| Indexed cost of acquisition |
|
7,50,000 X 480/351 = Rs. 10,25,641 |
| |
|
|
| Add: |
|
|
| Brokerage |
|
Rs. 10,000 |
| Total Cost |
|
Rs. 10,35,641 |
| Sale Value |
|
Rs. 11,20,000 |
| Long-term capital gains |
|
Rs. 84,359 |
| Tax payable at 20 percent |
|
Rs. 16,871 |
If a new property is acquired or constructed for a value greater than the Capital gains amount of Rs. 84,359.00 the tax of Rs. 16871.00 need not be paid. Similarly, if an amount of Rs. 84,359 or more is invested in specified bonds there will be no tax liability.
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