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As we all know only too well, the property market is smoking hot. A number of deals would have taken place throughout last year. Those who have sold property would have earned handsome capital gains and would be keen to know how this can be protected from tax. And those who have bought property would most likely sell the same sometime or the other, so they may as well learn the nuances of saving tax. Let’s see how we can save on capital gains tax on property sale.

First and foremost, it must be pointed out that we are dealing with only long-term capital gains tax here, i.e., capital gains earned on sale of only such property that has been held for over three years. Any profit from sale of property owned for less than three years would be categorised as short-term capital gains. Such short-term gains get added to your other income (salary, interest etc) and consequently, investments eligible for Sec 80C deduction (PPF, ELSS, NSC etc) are the only way to save tax on the same.

However, on long-term capital gains, you can save tax in two ways. The first one is by way of investing in NHAI or REC bonds within six months of sale. This is indeed the simplest way, though the problem is that you have to be fortunate enough for the bonds to be available within the time limit applicable to you. Secondly, there is a cap of Rs 50 lakh per financial year. So if yours is a big ticket sale, this avenue may not be that useful. Of course, you are free to time the sale in such a manner that the six months overlap two financial years, thereby doubling the limit to Rs 1 crore. For example, if the sale is effected in say January of any year, the six-month period expires in June - and since June falls in the next financial year, ipso facto, the limit doubles.

Another way of saving the tax is through investing the capital gain amount in another property. There are several conditions under which this deduction is available and let’s examine these. First and foremost, it has to be a residential house property that is sold, not a commercial one. (For commercial properties, you will have to take recourse to Sec. 54F where the net sale proceeds need to be invested, not just the capital gain amount). However, note that residential property doesn’t mean that it has to be self-occupied — the property could as well have been rented out. Secondly, this deduction is only available to individuals and Hindu undivided families (HUFs). So, if a company or a partnership firm were to sell property, this deduction isn’t available.

To claim the exemption, the taxpayer has to purchase another ready residential house property or buy a residential property under construction. While a ready-to-possess house should be bought either within one year before or two years after the date of sale, an under construction property has to be purchased within three years of date of sale. Note that the construction could have commenced anytime, there is no stipulation thereon. In other words, the date of commencement of construction is irrelevant - it could have commenced even before the sale of the original property.

Also, there is no necessity of there being a live link or a direct nexus between the amount of capital gain and the cost of the new house. For instance, a taxpayer can invest the sale proceeds and use housing finance to buy the new house. As long as the value of the loan is equivalent to the capital gain, exemption is available. Of course, if the loan value is lesser than the capital gain, exemption is available to the extent of the loan value.

There is a three-year lock-in on the new house. So, if the new property is sold within three years from the date of purchase, the exemption given earlier would be reversed.

As we have learnt so far, taxpayers have two or three years, as the case may be, to buy the new house.

However, there is a small hitch, in that, for a particular financial year, the last date of filing the tax return is July 31. What happens if you haven’t finalised the deal before the tax filing date? In terms of an example, for a property sold on say January 25, 2007, the taxpayer has till January 24, 2009 to buy a new house or till January 24, 2010 to buy a house under construction. However, the last date for filing tax return for FY 06-07 falls on July 31, 2007. Therefore, if the new house isn’t purchased by then, the taxpayer will have to deposit the amount intended for purchase of the new house in a special deposit known as “Capital gains deposit account scheme” (C-deposit) offered generally by public sector banks. The proof of the C-deposit should be submitted along with the return of income. Payments towards the new house should be made only by withdrawing from such C-Deposit within the time limits explained above.

If the amount deposited is not fully utilised for purchase or construction of new property within the stipulated period, then the amount not utilised shall be taxed as long-term capital gain of the year in which the period of three years from the date of sale expires.

Taxpayers should note that there is controversy on whether this exemption from long-term capital gains tax is limited to the purchase/construction of one single new house or whether the purchase/construction of more than one house also qualifies for exemption. For example, if the capital gain amount is say Rs 50 lakh, should it be invested in the purchase/construction of one house or would Rs 25 lakh invested in two houses also do? This becomes a particularly pertinent point in the case of distribution of assets among family members.

Now, the villain causing the confusion is the article ‘a’ used before ‘residential house’. The word seems to imply that the exemption would be available only against purchase of one residential house and not two or more.

Apparently, tax officials have been taking the meaning of ‘a’ literally as only one property in spite of judgments to the contrary, most notably D Anand Basappa v. ITO [2004] 91 ITD 53 (Bang.) where it was held that to claim deduction under section 54, there is no bar on acquiring more than one residential house. A CBDT clarification is long overdue.

sandeep.shanbhag@gmail.com