If you have purchased a residential property as an investment, you must be on a lookout to exit your investment with heavy capital gains. Finding a buyer at a price that you are willing to sell at may be a difficult task these days. However, amidst this concern about finding the right buyer, don’t forget about other operational, statutory and taxation aspects that arise when you sell your residential property. Though there are many aspects to take care off when you are selling a property, I will focus only on aspects pertaining to Income Tax (or the capital gains tax) in this post.
1. Tax Benefits under Section 80C Can Be Reversed
If you purchased your house on a home loan, you would get tax benefits for principal repayment under Section 80C and interest payment under Section 24. Tax deduction for principal repayment under Section 80C is capped at Rs 1.5 lacs per financial year. Benefit for interest payment is capped at Rs 2 lacs per financial year for a self-occupied property. In case of a let-out property (or deemed let-out property), there is no cap on tax benefit for interest payment.
If you sell your property within 5 years from the end of the financial year in which you got the possession (or the construction was completed), then the tax benefits availed under Section 80C for principal repayment will be reversed i.e. tax liability for the previous years will be reassessed after withdrawal of tax benefit. For instance, if you got possession of the house in November 2012, the tax benefits for principal repayment under Section 80C will be reversed if you sell before March 31, 2018. Fortunately, there is no such reversal of tax benefits for interest payment. You must note tax benefit for principal repayment is not an exclusive benefit. Investment in PPF, ELSS, life insurance etc also qualifies for tax deduction under Section 80C. Hence, it is quite possible that your tax liability (for the previous years) may not change much even after reversal of tax benefit for principal repayment. Hence, if you had taken a home loan to make invest in residential property, you must keep this aspect in mind when you sell your property.
2. Holding Period Affects Your Tax Liability
If you sell your residential property within three years from the date of acquisition, then the resulting capital gains are considered short term capital gains and taxed at your marginal income tax rate. If you sell your residential property after three years from the date of acquisition, then the resulting capital gains are considered long term capital gains and taxed at 20% after accounting for indexation. You can see the long term capital gains face a much favourable tax regime. Hence, if you have not completed three years from the date of acquisition, you may consider waiting for some time before you sell the property so that the resulting gains are long term capital gains.
An additional point to note is that date of acquisition. What is the date of acquisition? Is it the date of sale-purchase agreement (between you and the builder), date of allotment letter or the date of possession? Now, this aspect is quite confusing. Many people have gone to the courts and courts have taken decision based on specifics of the case. I am not a tax expert. Hence, I will not venture into this aspect. Suggest you to go through articles on MoneyControl and Business Standard for better clarity on this topic. You are advised to talk to a Chartered Accountant before you jump to any conclusion.
3. Tax Benefits under Section 54 Can Be Reversed
There are a few ways in which you can avoid paying tax on long term capital gains on sale of residential property. Such relief is available under Section 54. Do note that the relief under Section 54 is only for Long term capital gains (and not short term capital gains) on sale of residential property. You can use the long term capital gains to purchase another residential property within a period of 1 year before or 2 year after the sale of house. Alternatively, you can use the long term capital gains to construct another house within 3 years from the date of sale of property. However, you must note that the tax relief under Section 54 can also be reversed if you sell the NEW property within 3 years from date of purchase or construction.
Let’s consider this example. You sold a house resulting in long term capital gains of Rs 40 lacs. You invested the gains in a new property and purchased the property for Rs 60 lacs. After two years, you sold this new property for Rs 90 lacs. In this case, since you sold the property within three years, the tax relief under Section 54 will be reversed. How is the relief reversed? In this case, the cost of the new property (for the purpose of capital gains calculation) will be reduced by Rs 40 lacs (capital gains saved earlier).
Cost of the new property will be considered as Rs 60 lacs – Rs 40 lacs = Rs 20 lacs.
Capital gains will be Rs 90 lacs – Rs 20 lacs = Rs 70 lacs.
Do note this capital gain of Rs 70 lacs is a short term capital gain and hence will be taxed at marginal income tax rate (as per income tax slab). There is no benefit of indexation. And there is no way to avoid tax on Short term capital gains.
Hence, if you are selling a property that you had purchased to seek relief under Section 54, you must keep this aspect in mind. If you make a mistake, be prepared to shell out heavy sums as income tax.
4. Tax Deduction at Source (TDS) on Sale of Property
Though this is an aspect to be taken care of when you are a buyer, I will still cover this aspect because you are affected as a seller. If the transaction value exceeds Rs 50 lacs, the buyer must deduct TDS at the rate of 1% from the entire sale consideration. This is specified under Section 194-IA of the Income Tax Act. The buyer has to deposit this tax with the Government. The TDS shall be deducted on the entire sale consideration (and not just the amount exceeding Rs 50 lacs). If the amount is being paid in instalments, the buyer must deduct TDS on each instalment. In case the seller does not furnish PAN, the applicable rate of TDS shall be 20% (and not 1%). Go through this detailed post of ClearTax for more on TDS on sale of property.
By introducing TDS, the Government puts the onus on the buyer to report the transaction by way of deducting and depositing TDS. The buyer has little incentive to hide the transaction because he does not make any capital gains on purchase of property (only the seller does). This may result in better reporting and leave a taxation trail. As a seller, your tax liability (on capital gains) is not extinguished just because the buyer has deducted TDS. You must pay remaining income tax (as advance tax or at the time of filing income tax returns). In case, excess tax has been deducted (as TDS), you can claim it back at the time of filing income tax returns.