How to save tax on long-term capital gains?

What is Long-Term Capital Gain?

Any earning you make is considered a Long-Term Capital Gain when you sell an investment or other asset you've held for a certain period (usually over a year). The required holding period to categorize an asset as a long-term capital asset varies based on its nature. Listed equity shares and equity-oriented mutual funds qualify if held for more than 12 months, while unlisted equity shares and immovable properties such as land, buildings, or houses require a holding period of over 24 months. Debt-oriented mutual funds and other assets generally fall under the long-term class if held for more than 36 months. The tax rates applicable to LTCG differ based on the nature of the asset. A 10% tax is imposed on gains exceeding ₹1 lakh per year for listed equity shares and equity-oriented mutual funds. On the other hand, LTCG from other assets is taxed according to the individual income tax slab rates. This categorization and associated tax structure aim to provide a slight approach to taxing long-term capital gains across diverse asset classes.

Saving Tax on LTCG from Property Sale: Sections 54, 54F & CGAS

Selling a property can generate significant long-term capital gains (LTCG), subjecting you to tax liability. However, the Indian Income Tax Act offers provisions to reduce or defer this tax burden, primarily through Sections 54 and 54F and the Capital Gains Account Scheme (CGAS).

Exemption Under Section 54:

Section 54 of the Income Tax Act in India pertains to Long-Term Capital Gains (LTCG) arising from the sale of a residential property, offering provisions for LTCG tax exemption if the proceeds are reinvested in another residential property. To qualify for this benefit, the reinvestment must occur within one year before or two years after the sale. Additionally, the new property must be located within the country. The maximum exemption allowable under Section 54 is equivalent to the Long-Term Capital Gains incurred, providing a regulatory framework to encourage the timely and domestic reinvestment of proceeds from the sale of residential properties.

For example, Ms. Sharma sells her apartment for ₹80 lakhs, generating an LTCG of ₹30 lakhs. She buys a new flat for ₹40 lakhs within two years. LTCG exempt = ₹30 lakhs (maximum). The remaining ₹10 lakhs are taxable at the applicable slab rate.

Exemption Under Section 54F:

Section 54F of the Income Tax Act in India mirrors the provisions of Section 54, providing exemptions for Long-Term Capital Gains (LTCG). However, unlike Section 54, Section 54F extends its applicability beyond gains specifically derived from property sales, encompassing any LTCG. To avail of this exemption, the taxpayer must reinvest the proceeds in a residential property, adhering to the same conditions as outlined in Section 54. These conditions include a timeline for reinvestment, requiring the taxpayer to invest within one year preceding the sale or two years subsequent to the sale. Essentially, Section 54F offers a broader scope for tax relief, encouraging the reinvestment of LTCG from various sources into residential properties.

For example, Mr. Patel sells shares for ₹50 lakhs, generating a LTCG of ₹15 lakhs. He buys a new house for ₹20 lakhs within one year. LTCG exempt = ₹15 lakhs (maximum). Remaining ₹5 lakhs are taxable at the applicable slab rate.

Note:

• You can claim a partial exemption under both sections if the reinvestment amount is < LTCG.
• If reinvestment takes longer than the specified period, the exemption is reversed and taxed as income in the year of completion.

Capital Gains Account Scheme (CGAS):

For the deferral of Long-Term Capital Gains (LTCG) tax liability, an option available under the Income Tax Act involves parking the gains into Capital Gains Accounts Scheme (CGAS)-approved bonds within six months of selling the asset. To qualify for this deferral, a minimum investment of ₹25 lakhs is required, and the invested amount is subject to a lock-in period of three years. It is important to note that any interest earned on these bonds is taxable as income. The primary benefit of this scheme lies in its ability to postpone the LTCG tax liability until the maturity of the bonds or until the gains are reinvested in a specified asset in accordance with the rules of the CGAS. This approach provides taxpayers with a strategic means to manage their tax obligations associated with long-term capital gains.

For instance, Mr. Khan sells land for ₹1 crore, generating a LTCG of ₹40 lakhs. He deposits ₹40 lakhs in CGAS bonds. No LTCG tax is payable for three years. The interest earned on these bonds will be included in his taxable income.

Case Study:

Mr. Arun: I have a rural agricultural land that my forefathers purchased back in 1850. I want to sell it now. Will the capital gains be subject to tax?

Tax2win’s experts: Long-term capital gains on the sale of rural agricultural land are not subject to tax. Therefore, your tax liability will be nil. However, please note that this exemption is not applicable to the sale of urban agricultural land.

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Saving Tax on LTCG from Sale of Other Assets: Section 54EC

Section 54EC of the Income Tax Act, 1961 offers a valuable option to exempt long-term capital gains (LTCG) earned from the sale of any asset other than a residential house property. To claim this exemption, you need to invest the entire sale proceeds in specific notified government bonds within six months of the asset sale.

Conditions and exemptions:

• Eligible assets: Any asset held for more than 24 months (except land held for more than two years and used for agricultural purposes), such as gold, jewelry, shares, debentures, or immovable property other than residential houses.
• Investment period: The entire sale proceeds must be invested in specified bonds within six months of the asset sale.
• Lock-in period: The bonds must be held until maturity, typically five years. Early redemption attracts a penalty and negates the tax exemption.
• Tax exemption limit: No limit on the amount of LTCG that can be exempted under this section.
  Example: Upon selling his old gold for Rs. 10 lakhs, Mr. Sharma realizes a long-term capital gain (LTCG) of Rs. 5 lakhs. To benefit from a tax exemption, he promptly reinvests the entire proceeds of Rs. 10 lakhs into NHAI bonds within six months of the asset sale. As a result, Mr. Sharma's entire LTCG of Rs. 5 lakhs becomes eligible for full exemption from taxation. This strategic investment not only preserves his capital but also leads to significant tax savings, amounting to Rs. 50,000, assuming a 10% tax rate on the capital gain. The timely reinvestment in NHAI bonds thus serves as a tax-efficient strategy, aligning with the provisions outlined for capital gains exemption under the prevailing tax regulations.
• Eligible Bonds: Currently, the following bonds issued by the National Highways Authority of India (NHAI) and Rural Electrification Corporation Limited (RECL) are eligible for Section 54EC exemption:
  • NHAI Series 11 Tax-Free 5-year NHAI Bonds
  • NHAI Series 12 Tax-Free 5-year NHAI Bonds
  • RECL Tax-Free 5-year Bonds

Note: Always refer to the latest list of eligible bonds published by the government before investing.

Saving Tax on LTCG from Equity Investments with Section 112A

Section 112A of the Income Tax Act 1961, governs how long-term capital gains (LTCG) from the sale of listed equity shares and units of equity-oriented mutual funds are taxed. While exemptions offer significant tax savings, understanding the conditions and calculations is crucial.

Exemptions under Section 112A:

• ₹1 lakh of LTCG in a financial year is exempt from tax. This incentivizes long-term equity investments.
• If you reinvest the entire LTCG amount within six months into specified bonds like Capital Gains Bonds (CGBs), National Highways Infrastructure Development Corporation Ltd. (NHIDCL) bonds, etc., the LTCG tax liability is nil.
• You can claim exemption on LTCG if you utilize it to purchase a new residential property within one year before or two years after selling the equity asset. Alternatively, use the gains to construct a new house within three years. The exemption is capped at the cost of the new property.

Conditions:

• The equity shares or mutual fund units must be held for more than one year to qualify for LTCG benefits.
• The maximum investment allowed under Section 54EC is Rs. 50 lakh in a single financial year.

Example: Upon the sale of equity shares, an investor accrues a Long-Term Capital Gain (LTCG) amounting to Rs. 1.5 lakh. Without any exemptions, the LTCG tax is calculated as the amount exceeding Rs. 1 lakh multiplied by the applicable rate, resulting in a tax liability of Rs. 5,000 at a 10% rate. However, by leveraging the provisions of Section 54EC, the investor can potentially eliminate this tax obligation. If the entire LTCG of Rs. 1.5 lakh is judiciously invested in specified bonds as stipulated by Section 54EC, and the investor becomes eligible for a complete LTCG tax exemption from paying any tax on the gains. This strategic use of the Section 54EC benefit demonstrates how investors can optimize their tax liabilities through prudent financial planning and adherence to the regulations governing capital gains exemptions.

If you are still wondering how to save LTCG tax, you should know that apart from those mentioned above there are numerous hacks to save taxes. Want to save more tax? Get in touch with our experts and keep more of your long-term capital gains. Book a Call with a Tax Expert Now!