How to Save Tax on Capital Gains in India?

Capital Gains Tax or CGT is a tax levied on assets of individuals and corporations. The assets subject to capital gain tax are Stocks, bonds, real estate, and other properties. 

So, if you plan on trading your property, you will be subject to capital gains tax on the profits made after deducting the indexed cost of acquisition and inflation, which can vary widely based on the holding term of a capital asset.

However, many options exist for reducing a property’s capital gain tax upon sale. 

Let’s check it out!

Definition of CGT:

The term “capital gains” refers to the profit made by an investor when selling an asset for more than they paid for it. 

Capital investments include properties like houses, cars, and jewelry. The Capital Gains Tax (CGT) depends on whether the gain was made quickly or over a long period.

The following percentage of tax deduction is available under such circumstances:

• Capital gains held for more than a year are subject to a 20% tax, plus surcharge and education cess.
• Capital gains on the sale of Equity shares are 10% over Rs. 1 lakhs.

CGT on Long-Term Assets

Long-term CG (LTCG) taxation for debt and equity funds is distinct. Long-term profits in equity funds are not subject to taxation, whereas gains in debt funds are subject to a 20% tax indexed upwards. When calculating the value of an asset, indexation means taking inflation into account.

While LTCG is qualified for tax deductions, short-term profits are not. By following the guidelines outlined in the Income Tax Act, you can legally minimize your long-term capital gains tax liability. 

For instance, reinvesting the home sale proceeds into a residence is one of the primary ways to avoid capital gains tax.

The Three Primary LTCG Tax Exemptions:

Sec 54

LTCG from selling a home and subsequent investment in another home is the subject of Section 54.

• Dispensations Permitted By Section 54

You are only eligible for a deduction toward the purchase of one home. Further, you can only claim an exemption for the first home’s price if you utilize the capital gains to finance multiple purchases.

• Only if you are purchasing a home in India do you qualify for the exemption provided by Section 54. You must pay LTCG tax on selling any residential property you buy outside the country.
• The proceeds from the sale of your previous home must be used to acquire a new home, which you must live in for at least three years before selling. If not, then you will lose the benefit you gained under Section 54 and be subject to the LTCG tax.

• Exemptions as per 54EC

When you sell your home and put the money you get from the sale toward the purchase of certain bonds, you will have long-term capital gains as defined under Section 54EC.

• Only the specified bonds and securities purchases will qualify you for the exemption. Therefore, get the lowdown from your accountant.
• If you sell these bonds three years before the date of purchase, you will lose the tax exemption.
• Even if you borrow money against these bonds within three years of purchase, the exemption will be nullified.

Sec 54 F

Long-term capital gains from selling an asset other than a home and the subsequent use of the funds to purchase a home are addressed in Section 54F.

Exemptions as per 54F

• You can only buy one home, which must be located in India. You can’t sell it for at least three years, which are restrictions placed on home purchases under Section 54, so they apply to Section 54F.

Capital Gains Account Scheme (CAGS)

LTCG can be placed in a Capital Gains Savings Account (CGS) if the account holder cannot invest the money within the allotted time. However, the funds must be utilized within a specified time frame to construct or acquire a new primary or secondary residence.

Sections 54 and 54F can be used in tandem with the Capital Gain Deposit Account (CGDA) Scheme, 1988. 

Capital gains not used when an individual files their income tax return may be deposited into a public sector bank under the CGDA Scheme. This account has a two-year (in the event of a new home purchase) or three-year (in all other cases) time limit on withdrawals (in case you are constructing a new house).

The funds must be used only to purchase a primary residence before the tax return filing deadline. The capital gains will be taxable if the money is not used to purchase a home within the specified time frame.

The annual rise in inflation and prices means that long-term capital sales typically provide substantial gains. Therefore, if you invest the money wisely, you can keep 20% of the money that would otherwise go to taxes.

Tips to save money on CGT:

You can, however, significantly lessen the Captial Gains tax by employing one of the following strategies:

• Residential Property Purchase and Construction Tax Exemptions under Section 54F

It is common practice for people to sell their previous residence to finance the purchase of a new one. 

If you meet the following requirements of Section 54F, you can avoid paying CGT while utilizing profits from selling your old property to pay for your new property.

• Purchase a new home one year before selling your current home.
• You can buy a new home or build one within two or three years of selling your current home. 

You won’t get the exemptions if you sell the new home before the three-year mark. 

Here, the three-year mark begins on a new home’s purchase or construction completion date. Certain requirements must be met to be eligible for the exemption provided by Section 54F. These are:

• Individuals and Hindu Undivided Families (HUF) are eligible for the tax break.
• The revenues from the sale must be put toward the following to qualify for the exemption:
• To buy a brand-new house a full year before the sale is scheduled.
• Within two years of the asset’s sale date, acquire a primary residence.
• The buyer must build a house within three years of the asset’s sale.

Currently, only one home falls under Section 54F jurisdiction. It paves the way for the sale of commercial property to fund the acquisition of a home. You can refrain from paying CGT if you invest the total amount in acquiring the replacement property.

It is intended for those selling a home to use the proceeds to buy another home to be prime candidates for the exemptions provided under Section 54F(i).

• Invest in Bonds for Capital Gains Under Section 54EC

You can utilize capital gains bonds if you sell a property and don’t plan to buy another home with the money. 

Let’s have a look at the characteristics of capital gains bonds. 

• When an investor purchases a capital gain bond, also known as a 54EC bond, they are guaranteed to be immune from federal income tax on any capital gains they may realize from selling the bond. 
• Investment in 54EC bonds can lower the tax burden resulting from the proceeds of real property.
• An investor can refrain from paying CGT on any profit from selling these bonds. It is possible to avoid paying CGT entirely by reinvesting property proceeds.
• The yearly interest rate offered by these bonds is between 5% and 6%, below the rates offered by fixed deposits.
• The money from the sale of the property needs to be invested no later than six months after the sale.
• It’s binding for five years. Automatically redeemed once five years have passed from the initial purchase date of the bond.
• These bonds are not transferable or tradable in any way.
• The minimum investment in each bond is Rs. 10,000, and the maximum is Rs.50 lakhs.
• Capital gains investments cannot exceed Rs 50 lakhs.
• The bonds are available in both physical and electronic (demat) forms. AAA-rated capital gains bonds are a safe investment option.
• You can purchase bonds from either NHAI or REC through the banking system.

This is intended for people who aren’t looking to buy a new home. They can fetch capital gains tax savings through bonds.

• Investment Plan for Capital-Gains-Accounts

It could take time to save enough money to buy a new house. Purchasing a home or apartment involves several steps, including searching for the right place, talking to sellers, and filling out paperwork.

For the time being, at least, capital gains accounts can provide some respite. 

Think of it as a secure place to leave your capital gains tax while you look for a new home. As per Sections 54 and 54F, investing in long-term assets can help save tax from long-term capital gains. 

Profits from selling a home or other property can be placed in a capital gains account at a public sector bank or another financial institution recognized under the Capital Gains Accounts Scheme of 1988.

• Put money down for the future.

If you successfully identify high-quality companies and then maintain a long-term position in their shares, you will be subject to a relatively low capital gains tax rate. 

Capital gains taxes can be postponed by purchasing another investment property of the same kind after selling one. However, these gains are just delayed and will be subject to taxation in the future.

Re-investment can fetch you up to tax exemption benefits up to Rs. 2 crores. This is, of course, much simpler to say than to accomplish. The success of a business might rise and fall over time, leaving you with the option (or need) of selling sooner than expected.

• Make use of tax-deferred retirement programs.

Investing in a retirement plan allows your money to grow tax-free programs. 

• 401(k) for private business accounts
• Individual retirement account 
•  403(b) for a nonprofit organization
• 457 (b) for public sector organization
  

Sale and purchase of investments can be made within retirement accounts without paying CGT. When you take money from a typical retirement plan, any gains will be taxed as ordinary income, but if you are working, you are taxed in a low band. 

However, the withdrawals will be completely tax-free if you have a Roth IRA and remove the funds per the rules.

Moreover, Investors close to retirement may wish to hold off on selling non-retirement investments until they no longer need the money. There is a possibility that their capital gains tax payments could be decreased or eliminated if their retirement income is sufficiently modest.  

Tax breaks are available for people who participate in some retirement plans and set money aside in retirement accounts. You can reduce your capital gains tax if you employ them to their maximum potential.

Investments bought and sold within such an account structure will not hinder the structure of capital gains taxation. Contributing on a pre-tax basis also has the added benefit of lowering your current taxable income. 

But suppose they are already in a tax-free category. In that case, they should be aware of one crucial consideration: a sizable capital gain could raise their taxable income to the point where they would owe taxes on their profits.

Capital losses can reduce your tax on capital gains and regular income. After that, any unused funds can be carried over to the following fiscal year.

• Use investment losses to offset your profits.

It is possible to reduce the tax you pay on investment gains by taking advantage of a loss you may have sustained. 

All potential capital losses should be utilized immediately. This is what you need to do if you have any capital losses this year or any leftover losses from past years:

• Put these losses toward the current year’s capital gains 
• Start with the early failures.

For instance: Let’s suppose you have two stocks, one of which is now worth 10% more than you purchased for it and the other 6% less. If both equities are sold, the capital loss from one would be applied to the CGT of the other one.

Of course, in a perfect world, your investments would only go up in value, but setbacks sometimes occur, and this is one approach to salvage at least some of the value lost.

If your capital loss for the year is more than your capital gain, you can deduct up to Rs. 5,000. The remaining loss can be taken forward into subsequent tax years.

• Select a Cost Function

For shares of a firm or mutual fund that you’ve purchased at varying values throughout time, the cost basis for the sold shares must be calculated. 

The four ways investors might compute a cost basis with:

• LIFO (Last In, First Out)
• the average cost (used for mutual fund)
• dollar value LIFO, 
• specific share identification 

Any funds stashed away in a capital gains account at one of the qualifying financial institutions can be deducted from your taxable income. There won’t be any tax imposed on it. Therefore, your financial condition and goals should guide your decision on the most appropriate cost basis method. 

Suppose your holdings are small, and you don’t want to keep meticulous records. In that case, you can probably get away with utilizing the average cost approach for selling shares of a mutual fund and the FIFO method for all your other investments. 

However, a three-year holding period is required before the money in the account is considered capital gains and subject to taxation in the following fiscal year.

It is intended for people who invest in a capital gains account scheme. It may be the best option if you plan to buy a home with capital gains but need a safe location to store the money until you’ve worked out the formalities.

Final notes

Saving on LTCG can be a tedious task!

However, the above points are some of the best options available for saving options on LTCG. 

For some gains, however, the taxpayer may choose to pay tax at a rate of 10%, plus surcharge and cess if appropriate. Long-term capital gains do not qualify for a tax deduction under sections 80C through 80U.