Real estate industry has transformed. Gone are the days when families used to painstakingly oversee the construction of their residential homes. They now opt for houses that are delivered as completed units by the developers, builders and group housing societies. Given the time constraints and high disposable incomes of households, the residential property market has carved out its niche for their buyers. Families now choose location, projects, specifications, floor, direction and whatever they can think of as their requirement for their residential unit. The completed units with fit outs, utilities, and equipment are a standard in the present times. Purchasing units and selling and buying again are pretty common these days, because people have taken to real estate as an investment. Let’s look at the tax implications of carrying out these transactions.
Short-term Vs. Long-term Capital Gains: For a residential unit, any profit arising by selling the unit after owning it for a period less than or equal to 3 years is considered short-term capital gains. This capital gain is added to the total income and taxed according to the individual’s tax slab rate.
If the unit is sold after three years from the date of purchase, the profit arising by selling it is treated as a long-term capital gain and is taxed at 20% after indexation. What is indexation? Indexation is the cost adjustment according to the inflation that happened during the years when the unit was held by the owner. One can avail of several tax exemptions in case of long-term capital gains, however there are no such exemptions in case of short-term capital gains.
Tax Exemptions: For LTCG (long term capital gains) arising by selling a residential unit, the capital gain is completely exempted from income-tax if it is reinvested totally in another residential unit within 1 year before the sale or within 2 years after the sale. If one is not keen to purchase a new residential house property to avail tax deduction from capital gains then she can also save the tax by investing in specific bonds of National Highway Authority of India or Rural Electrification Corporation Limited (Sec. 54EC). Long Term Capital Gains would be computed by deducting the cost of acquisition and improvement, as increased by cost of inflation index (CII), from the net sale proceeds. Long Term Capital Gain is taxed @ 20%.
Under-construction vs. Approved constructed Unit: Many times residential unit holders get confused whether the same capital gains tax rules are applicable for under-construction property. Since the unit is not ready for living, the question is whether the investment is of same nature or is it different? Any allotment to an under-construction residential unit is a ‘right to acquire’ the unit. It is not the same as owning a residential unit. Since the nature of capital asset is different, the tax deduction rules are different as well. To determine whether the capital gains are short-term or long-term, the same rules apply as mentioned above. However the tax deductions to be availed to exempt capital gains are different. For an under-construction property, any profits arising by selling the right before completing 3 years of holding it is considered short-term capital gains, taxable as per the income tax slab. But any profit arising by selling the right after holding for more than 3 years will form long term capital gains. In a LTCG scenario of a ‘right-to-acquire’ a property, to exempt the capital gains from taxes, the entire net sale proceeds need to be reinvested, within 1 year before the sale or 2 years after the sale of the right. For specifics, one must consult his/her financial planner and/or tax advisor.
Amit Kukreja is a fee-only financial planner (FPSB) and Investment Adviser (SEBI). He is the founder of WealthBeing Advisors, a financial planning and wealth advisory firm.