Navigating Long-Term Investments: Smart Strategies to Trim Capital Gains Tax in India
In their strategy of financial planning, one must master the art of tax saving, especially concerning long-term investments. Investors can benefit from tax savings to a great extent, sometimes even impacting their choice of investments. All gains arising from a capital asset are deemed Capital Gains for income tax considerations, thereby becoming subject to capital gains tax. Among these assets, land holds a significant position, and its increasing value can lead to substantial capital gains when sold.
However, it’s crucial to highlight that agricultural land situated in rural areas of India is exempted from the definition of a Capital Asset. Consequently, the sale of such land does not attract capital gains tax. Investors can use this to their advantage and make strategic structural changes to their investment portfolios to take advantage of such provisions and increase their chances of profit.
The tax liability depends on the classification of gains as either short-term or long-term. In the context of land, gains are treated as short-term if the ownership duration spans up to 24 months prior to the sale. On the other hand, if the land was held for a period exceeding 24 months, it falls under the purview of long-term capital gains. Unlike other asset classes, the definition of LTCG is when the equity is held for more than 12 months (1 year). In case equities are sold in less than 12 months then it will be classified as STCG.
Tailoring Your Investment Choice for Tax Efficiency
LTCG is generally 20% in India for asset gains but for equities and debt funds, it can be different. When dealing with Equity Funds, the duration of holding significantly influences the tax implications. If you redeem your fund units within a year of acquiring them, your gains fall under the Short-Term Capital Gains (STCG) category, subjecting you to a 15% tax rate on these gains. However, should you hold your Equity Fund units for over a year before redeeming, you become liable for Long-Term Capital Gains (LTCG) tax on your profits.
The LTCG tax rate for Equity Mutual Funds stands at 10% of gains exceeding Rs. 1 lakh in a financial year. This implies that if your total Equity Gains amount to, let’s say, Rs. 1.1 lakh in a financial year, the 10% tax is applicable only on a surplus of Rs. 10,000. The initial Rs. 1 lakh of gains remain tax-free under this structure, creating a tax-efficient scenario for long-term investors in Equity Mutual Funds.
According to the latest budget of 2023, most of the common debt investment options are taxed at the income tax slabs applicable to their income. LTCG however, on some debt investment options is still taxed at 10% without the Indexation benefit. Listed Bonds for example are still taxed at 10% and will be eligible for LTCG.
Section 54EC: Purchasing Capital Gains Bonds
If you do not plan to acquire another property, rendering the Capital Gains Account Scheme unnecessary, you still have an avenue to save on capital gains tax by investing in specific bonds. Notable options include:
- Rural Electrification Corporation Limited (REC) bonds
- National Highway Authority of India (NHAI) bonds
- Power Finance Corporation Limited (PFC) bonds
- Indian Railway Finance Corporation Limited (IRFC) bonds.
These bonds, redeemable after 5 years, offer a tax-saving alternative. However, they cannot be sold before the expiration of 3 years from the date of the house property sale. Investors are granted a 6-month window for bond investment, but to claim the exemption, the investment must be made before the return filing date.
It is stipulated in the Indian tax law that a maximum investment limit of Rs 50 lakhs in these bonds within a financial year. This provides individuals with a structured and tax-efficient option to navigate capital gains tax implications when not looking to purchase a property.
Unveiling the Magic of Sections 54 and 54F: Your Gateway to Exemptions
Sections 54 and 54F of the Income Tax Act unfold opportunities for exemptions on capital gains tax, acting as a secret passage for tax-conscious investors. Section 54 applies to the sale of residential property, enabling individuals to reinvest gains in another residential property within specified timelines for tax exemptions. Section 54F broadens this scope to encompass any long-term asset, excluding residential houses. Harnessing these sections becomes a pivotal move in alleviating the tax burden on capital gains.
You can avail an exemption from capital gains tax by utilizing the proceeds from the land sale to acquire a residential property, potentially resulting in a tax-free gain, provided you meet the following conditions:
- Eligible Claimants: The exemption applies to individuals or Hindu Undivided Families (HUFs) and does not apply to companies, LLPs, or firms.
- Location Requirement: The new house must be situated in India.
- Timeline for Purchase or Construction: Acquire the house within one year preceding the land sale or within two years following the sale. Alternatively, construct a house within three years post the land sale.
- Non-Sale Stipulation: Refrain from selling the newly acquired or constructed house within three years of purchase or construction.
- Single Residential Property Ownership: As of the transfer date, you should not own more than one residential house, excluding the recently acquired one.
If these criteria are met, and you invest the entire proceeds from the land sale into the new house, you won’t be liable for any taxes on your gains. However, if only a portion of the sale proceeds is invested, the exemption will be proportional to the invested amount, calculated as the cost of the new house multiplied by the capital gains divided by the net consideration.
Deposit in Capital Gain Deposit Account Scheme
Section 54 and Section 54F also support the Capital Gain Deposit Account (CGDA) Scheme, 1988. In instances where the entire capital gains from a transaction cannot be utilized by the due date for submitting income tax returns, the unutilized amount can be deposited in any public sector bank under the CGDA Scheme. Subsequently, this deposited sum must be utilized within two years specifically for purchasing a new house or three years specifically for constructing a new house.
To benefit from this scheme, you are required to open the account before the deadline for filing your income tax return. Additionally, the funds held in this account should be exclusively utilized for the purchase of a residential property. Failure to utilize the funds within the specified time restrictions for acquiring a home will result in the imposition of capital gains tax on the deposited amount either retrospectively or from immediate effect, depending on the default.
Other frequently used methods of Tax Savings in India
Investors can use Equity Linked Savings Schemes(ELSS). ELSS mutual funds provide a twofold advantage of potential capital appreciation and tax savings under Section 80C of the Income Tax Act. Investing in ELSS not only reduces your taxable income but also offers an avenue for long-term wealth growth.
Engaging in Systematic Investment Plans (SIPs) within equity mutual funds offers a strategic approach, capitalizing on the advantages of rupee cost averaging and compounding. Notably, SIPs present a tax-efficient avenue as they fall under the Long-Term Capital Gains (LTCG) tax exemption for gains up to Rs. 1 lakh per year. This makes SIPs an attractive and tax-friendly choice for investors, aligning with long-term wealth accumulation goals.
Loss harvesting is a good strategy that involves selling underperforming investments to actualize capital losses. By doing so, investors can offset these losses against their capital gains, effectively mitigating the overall tax burden. This tactical approach not only helps in managing tax liabilities but also contributes to optimizing the overall portfolio performance.
Optimizing both portfolio diversification and tax savings, consider allocating funds to a mix of tax-efficient instruments. The Public Provident Fund (PPF) offers tax benefits and tax-free interest, emphasizing long-term security. The National Pension System (NPS) stands out for retirement planning, allowing deductions under Sections 80C and 80CCD(1B). Adding tax-saving fixed deposits, with their lock-in period and Section 80C benefits, further enhances the mix. This strategic combination not only promotes financial diversification but also ensures a tax-smart approach, providing a double benefit for a well-rounded investment portfolio.
Conclusion
When it comes to managing your money wisely, especially when the market is doing well, paying attention to taxes is essential. Tax-efficient investing simply means making smart choices to keep more of your earnings. By using these strategies and staying aware of tax rules, you can make the most of your returns, reach your financial goals, and avoid paying too much in taxes. Don’t forget to include tax planning in your money plans, and it’s always a good idea to talk to financial experts for advice that fits your specific situation. This way, you can grow your money smartly and achieve your financial dreams.
FAQs
- How to save capital gain tax on the sale of Residential Property?
A widely favoured method to save on taxes from the sale of residential property is by reinvesting the capital gains into another residential property. For eligibility under Section 54 of the Income Tax Act, 1961, the requirement is to acquire the new property either one year before or within two years after the sale. - Capital gains tax on the sale of property for Senior Citizens in India?
For Indian residents aged 80 years or above, there is an exemption from long-term capital gains tax if their annual income is below Rs. 5,00,000. Similarly, for residents aged between 60 to 80 years, the exemption from long-term capital gains tax in 2021 is applicable if their annual income does not exceed Rs. 3,00,000. - What is the meaning of long-term capital assets?
Any capital asset held by a person for more than 36 months immediately preceding the date of its transfer will be treated as a long-term capital asset. However, concerning certain assets like shares (equity or preference) which are listed in a recognised stock exchange in India, units of equity-oriented mutual funds, listed securities like debentures and Government securities, Units of UTI and Zero Coupon Bonds, the period of holding to be considered is 12 months instead of 36 months.
In the case of unlisted shares in a company, the period of holding to be considered is 24 months instead of 36 months. - In respect of capital assets acquired before 1st April 2001 is there any special method to compute the cost of acquisition?
Generally, the cost of acquisition of a capital asset is the cost incurred in acquiring the capital asset. It includes the purchase consideration plus any expenditure incurred exclusively for acquiring the capital asset. However, concerning capital assets acquired before 1st April 2001, the cost of acquisition will be higher than the actual cost of acquisition of the asset or fair market value of the asset as of 1st April 2001. This option is not available in the case of a depreciable asset. - If any undisclosed income [in the form of investment in capital asset] is declared under the Income Declaration Scheme, 2016, then what should be the cost of acquisition of such capital asset?
The fair market value of the asset as of 1st June 2016 [which has been taken into account for said declaration Scheme, 2016] shall be deemed as the cost of acquisition of the asset.
