Real estate is the most preferred investment asset class for Indians. Stocks come last on the list. Investing in real estate has some tax advantages. However, these benefits have many if and buts and the average taxpayer has difficulty understanding his/her use case.

Did you know that selling a home incurs different tax rates 24 months before and after purchase?

Did you know that the home you build has a different income tax bracket than the one you buy? Or is it not part of income tax at all?

Well, for better understanding, let’s discuss each one of the topics one by one.

Real Estate is a Capital Asset

Real estate is a capital asset. But not all real estate is a capital asset. Rural agricultural land is not considered a capital asset. This is because the income generated from selling rural farmland is tax-free. According to Section 10(1) of the Income Tax rules, any income derived from agriculture is exempt from income tax.

However, all other real estate forms, such as residential properties, commercial properties and land parcels, fall under the tax regime. Urban agricultural land also falls within the scope of taxation.

Capital Gains

The return on each asset considered as a capital asset is called capital gain. For example, if you buy a house for Rs 50 lakh and sell it for Rs 80 lakh, your capital gain is 80-50 = Rs 30 lakh.

Therefore, capital gains are nothing but self-interest in any buying or selling transaction.

Capital gains fall into two categories:

• Short-term capital gain (STCG)
• Long-term capital gain (LTCG)

STCG applies where the difference between selling and buying residential property is less than 24 months. LTCG is valid for 24 months.

STCG describes taxes in terms of personal income tax.

LTCG is taxed at a flat rate of 20%. There are many exemptions to the LTCG tax, which are discussed below:

Indexation Benefit

Indexation benefits take inflation into account. For instance, if you’re selling your house at a higher price, why are you paying more tax just because inflation is causing property prices to go up?

Therefore, the index advantage is introduced to eliminate this disadvantage. Indexation is considered in the LTCG but not in the STCG when dealing with taxes. This is fair because inflation has the least impact over the 24 months.

There are no exemptions from the STCG. Some exemptions are provided in the LTCG.

Let’s talk about these exceptions in the LTCG that are good for real estate investing.

Benefits Under Section 54

This section only provides for reducing your LTCG tax when selling a residential property. Houses can be bought or built. However, plots and commercial properties are outside its jurisdiction. According to Section 54, only individuals and Undivided Hindu families (HUF) can apply for this benefit.

To apply for benefits under this section, the residential property should be held for at least 24 months. So, you can’t buy a home every month and continue to receive benefits by selling it every month.

Because if you do, you will be covered by STCG, which does not waive benefits in any way. The upside is that you don’t have to pay LTCG tax at the flat rate of 20% (described above) on the profits you make on the sale of your home. You must buy another house with the amount you received from the previous property sale. In addition to purchasing an already built home, you can also build a new one. However, you cannot purchase land to apply for this benefit.

Additionally, the new property must be purchased within two years of the original property being sold. Properties purchased one year before the actual property was sold will also be used for this purpose. This period can be extended to 3 years if the taxpayer prefers to build the home rather than buy it.

If you sell your house for Rs 50 lakh and previously bought it for Rs 25 lakh, your capital gain is Rs 25 lakh. You will have to buy another property or up to two properties worth Rs 25 lakh; this way, you will not have to pay the 20% LTCG tax on this Rs 25 lakh. This saves Rs 5 lakh. There is no need to buy a property worth Rs 25 lakh. You can also buy another property worth Rs 50 lakh but only ask for the duty-free Rs 25 lakh.

Maximum LTCG Capping

These benefits don’t apply to real estate tycoons. The maximum LTCG for which the Section 54 exemption can be used is Rs 2 crore. Also, it does not apply to real estate agents and traders. This is because you can only enjoy this benefit once in your lifetime.

“Why not buy a new home and enjoy the tax benefits, then sell for cash and relax”? – Innocent taxpayers can question their chartered accountants.

This exemption cannot be revoked if the new property used to claim benefits is sold within three years of purchase. The individual will then be responsible for paying the LTCG tax in the next assessment year. Adding to the stringent regulations, LTCG must be kept in the bank’s dedicated capital gains account scheme. It cannot be held in a savings account.

Section 54EC

All capital assets – including real estate, plots and commercial properties- are within Section 54EC. Unlike section 54, all taxpayers can benefit under this section. To apply for LTCG benefits under section 54EC, the real estate should be held for at least three years.

After the property is sold, the LTCG should invest in designated bonds with a lock-up period of 5 years. This investment should be completed within six months of the property being sold. Investments can be made through National Highways Authority of India (NHAI) bonds or Rural Electrification Corporation (REC) bonds. Therefore, an investment of Rs 2.5 lakh in these bonds would be exempt from LTCG tax based on the above example.

In this section, up to Rs 50 lakh, LTCG can be claimed.

Unlike Section 54, no dedicated bank account is required here.

The returns on these bonds are very low, around 5-6%. These returns represent taxes based on income tax. Therefore, Section 54 takes precedence over Section 54EC.

Section 54F

All capital assets other than commercial real estate, plots and real estate are governed by Section 54F. The main difference between Section 54F and Section 54 is that the full sale value of the original real estate applies to purchasing a new ‘residential only property’.

So, according to the previous example, the entire Rs 50 lakh must be invested to buy a new property. If you invest only Rs 25 lakh, you will get 50% or 50% of LTCG (Rs 12.5 lakh).