CAPITAL GAINS ON RESIDENTIAL
PROPERTY – AN ANALYSIS
ANKIT N. ANJARIA, LL.B (Gen), ACA, CS Mumbai
Buying property for investment purposes and selling it
later at a higher price has become a common habit.
There is an aspect of these transactions which deals with
the tax on the profits gained, which the seller needs to
be aware of. If you sell real estate for a profit, you will
need to pay capital gains tax on the gain so earned. The
tax varies, depending on the time period the property
was held on to. And given the cost sensitive property
market, capital gains tax is surely an aspect which needs
to be looked at.
Capital Gain is by-far the most complex head of income
in the Income Tax Act, after Income from Business and
Profession. In this Article, I intend to throw light on
Capital Gains as well as certain frequently asked
questions on the topic.
The Income Tax, for the purposes of levy of capital gains
tax on an asset has, bifurcated assets into short term
asset and long term asset, depending on the type of the
asset and its period of holding and consequently, the
gain on the transfer of the said property shall be taken as
short term gain/loss and long term gain/loss
respectively. As far as property goes, it will be deemed to
be short term if the property is transferred within a
period of 3 years from the date of its acquisition. The
definitions of short term asset and long term asset have
been given under sections 2(42A) and 2(29A) of the Act.
It is a frequently asked question that incase of purchase
of an under-construction property, which date will be
considered as the date of acquisition viz. the date of
booking of the flat, or the date of receipt of possession?
The answer is where a flat is booked with a builder under
a letter of allotment or an agreement for sale, this would
represent only a right to acquire a flat and if such right is
acquired more than 36 months back, it becomes a longterm asset. However, when the possession of the flat is
taken, the period of holding would
once again commence from the
date of the possession of the flat
as the small right to acquire a flat
merged into larger right and small
right upon a merger would lose its
existence.
It is also important to note, that where an asset has been
acquired under certain modes specified u/s 47 the period
of holding of the previous owner will also be considered
in computing the period of holding of the assessee.It is
also pertinent to note the fact, that the capital gains tax
is levied not only on sale of the asset, but on transfer of
an asset, which has a wider connotation than the term
sale. The term ‘transfer’ is defined u/s 2(47) of the Act.
Sec. 2(47): Transfer in relation to a capital asset includes
sale, Exchange or relinquishment of the asset or
extinguishment of any rights therein or the compulsory
acquisition thereof under any law or conversion of the asset
by the owner in stock-in-trade of a business carried on by
him or the maturity or redemption of a zero coupon bond.
Thus, the definition seeks to include various other modes
of disposal of property other than sale. However, section
47 of the act also gives a list of those transactions, which
by definition may fall under the category of a transfer,
but are specifically exempt. Examples of such
transactions are:
- Transfer by way of gift or under a will or irrevocable
trust
- Transfer under a partial or a total partition of an HUF
- Transfer by a Holding company to its 100% subsidiary
company or vice versa
Computation of Capital Gains
Short Term Capital gains are computed by deducting the
cost of acquisition and the cost of improvement and all
the costs related to the transfer of the property (such as
brokerage etc.) from the full value of consideration.
Long Term Capital Gains are computed by deducting the
Indexed cost of acquisition and the Indexed cost of
improvement and all the costs related to the transfer of
the property (such as brokerage etc.) from the full value
of consideration.
It is now important to understand the meaning of the
terms ‘Full Value of Consideration’; ‘Cost of Acquisition’;
‘Cost of Improvement’ and ‘Indexation’
Full Value of Consideration (FVOC)
This is the amount for which a capital asset is
transferred. It may be in money or money’s worth or a
combination of both. Where the transfer is by way of
exchange of one asset for another, Fair Market Value
(FMV) of the asset received is the FVOC. It is important
to note that, the FVOC may not necessarily be construed
as the fair market value of the asset.
Where the capital asset transferred is land or buildings
or both, if the full value of consideration received or
accruing is less than the value adopted or assessed by
Stamp Valuation Authority the value adopted by such
authority would be taken as the full value of
consideration. If an assessee does not dispute such
valuation by the Stamp Valuation Authority, but claims
before the assessing officer that it is more than FMV,
assessing officer, may refer the case to the valuation
officer. If the FMV given by the valuation officer is less
than the value for stamp duty purpose, the FMV would
be taken as the full value of consideration. If FMV is
more than the value for stamp duty purpose, the value
for stamp duty purpose would be taken as the full value
of consideration. (Section 50C)
Cost of Acquisition
Cost of acquisition of an asset is the sum total of amount
spent for acquiring the asset. Where the asset was
purchased, the cost of acquisition is the price paid.
Where the asset was acquired by way of exchange for
another asset, the cost of acquisition is the Fair Market
Value of that other asset as on the date of exchange. Any
expenditure incurred in connection with such purchase,
exchange or other transaction eg. Brokerage paid,
registration charges and legal expenses etc., also forms
part of cost of acquisition. If advance is received against
agreement to transfer a particular asset and is retained
by the tax payer or forfeited for other party’s failure to
complete the transaction, such advance is to be
deducted from the cost of acquisition. However, a
situation may arise where advance money forfeited is
more than the cost of 'acquisition'. In such a case, the
excess of the advance money forfeited over the cost of
'acquisition' of such asset shall be a capital receipt not
taxable [Travancore Rubber & Tea Co. Ltd. v CIT (2000)
243 ITR 158 (SC)].
Also, as regards acquisition of property under certain
modes, the cost of acquisition shall be computed as per
section 49 of the Act.
According to Section 49, Where the capital asset became
the property of the assessee on distribution of assets on
total/partial partition of HUF, or under gift or will or by
succession or inheritance or under an irrevocable trust,
or acquired by the HUF from an assessee who gives his
separate property, the cost of acquisition of the asset
shall be the cost for which the previous owner of the
property acquired it, as increased by the cost of any
improvement of the asset incurred or borne by the
previous owner or the assessee, as the case may be, till
the date of acquisition of the asset by the assessee.
Previous year means, the one who did not acquire the
asset by a mode specified under section 47 of the Act.
Where the cost of acquisition cannot be determined, the
cost of acquisition shall be taken to be the Fair Market
Value as on the date of acquisition by previous owner.
Cost of Improvement
The cost of improvement means all expenditure of a
capital nature incurred in making additions or alterations
to the capital asset. However, any expenditure which is
deductible in computing the income under the heads
Income from House Property, Profits and Gains from
Business or Profession or Income from Other Sources
(Interest on Securities) cannot be considered as cost of
improvement.
Indexation
The value of a rupee today is not same as the value of a
rupee tomorrow. And thus the assessee loses
opportunity cost, being interest on the mount invested
in the property. In order to offset this loss, the Income
Tax allows the assessee to jack up the investment cost by
3.
inflating the cost of original investment and the cost of
any improvement made in the asset by using the
following formula:
Indexed Cost = Cost Inflation Index (CII) for year in which
asset is transferred or sold / Cost Inflation Index (CII) for
year in which asset was acquired improved
Tax Rates on Capital Gains, Set-off and Carry
Forward of Losses
Short term gains are charged to tax at the normal slab
rate of the assessee. Long term gains are taxed at 20%.
Long term loss can be set of only against long term gain,
whereas short term gain can be set off even against long
term gains. However, any capital loss (short term or long
term) cannot be set off against any other head of
income. Losses can be carried forward for a period of
eight subsequent years.
Exemptions Allowed While Computing Capital Gains
The Income Tax Act has also allowed various exemptions
while calculating the capital gains upon the transfer of
the residential property. This scheme of exemptions is
covered under section 54 of the Act.
1.
As per section 54 of the Act, if the residential property is
held by the assessee, being an individual or an HUF, for a
period of more than 3 years, the amount of gains earned
on the transfer of the residential property shall be
exempt if the following conditions are fulfilled:
2.
- The consideration is utilized for Purchase of
Residential House within 2 years after or 1 year prior
to the date of transfer of the asset; or,
construction of residential house within 3 years from
the date of transfer.
- In case New Asset is transferred before 3 years from
date of purchase/ construction, the Capital Gains
furnishing of return of income under section 139(1), it is4.
immaterial as to whether during intervening period same
was deposited in any bank as required under section
54(2) or utilized for some other purposes
exempted earlier will be chargeable to tax in year of
transfer of new asset.
- In order to avail the exemption, gains are to be
reinvested, before the due date of return u/s 139(1).
If the amount is not so reinvested, it is to be
deposited on or before that date in account of
specified bank/institution and it should be utilized
within specified time limit for purchase/construction
of new asset.
- As per Section 54H, where the transfer is by way of
compulsory acquisition, the period available for
acquiring the new asset u/s. 54, 54B, 54D, 54EC and
54F shall be computed from the date of receipt of
compensation and not the date of transfer.
Exemption is also allowed u/s 54EC, if the amount of the
gains is invested in bonds issued by the National
Highways Authority of India (NHAI) or Rural
Electrification Corporation of India (REC) redeemable
after 3 years.
As far as the claim of exemption under section 54 is
concerned, there have been various moot points, which
have been resolved by the judgments cited by the
authorities. Following are the controversies:
To claim deduction under section 54, there is no bar on
acquiring more than one residential house out of
proceeds of one residential house. D. Anand Basappa v.
ITO (2004) 91 ITD 53 (Bang.)
It is a frequently asked question as to whether, the
proceeds received on sale of the property can, during the
intervening period between the acquisition of the new
property be invested elsewhere other than the special
capital gains account?. This has been resolved in the
judgment in the case of Asst. CIT v. Smt. Uma Budhia
(2004) 141 Taxman 39(Kol.) (Mag.) wherein it was held
that if amount of capital gain is utilized by assessee for
purpose of construction of new asset before date of
Where an assessee who owned a house property, sold
the same and purchased another property in the name
of his wife, exemption under section 54 shall be
allowable. Was decided in the case of CIT v V. Natarajan
(2006) 154 Taxman 399 (Mad).