How you can avoid paying capital gains tax
There are some provisions in the Income Tax Act that make it possible for you to reduce your capital gains tax liability. The Act contains provisions regarding tax of capital gains arising out of transfer of a residential property. Capital gains tax is leviable on sale or transfer of a house. What constitutes a sale and transfer has been specified under the Income Tax Act.

Capital gains tax is computed on the indexed cost of the asset purchased, which is deducted from the sale amount received by the assessee. The indexed cost is computed according to the indexation rates notified by the Income Tax Department for each year.

The income from the house should be chargeable to tax under the head 'Income from House Property'. Other immovable properties, although owned by an individual, are not eligible for this exemption. The capital gains should arise from the transfer of a long-term capital asset. The house must be held for a period of more than 36 months before the date of sale or transfer. The house may be self-occupied or rented out.

In order to avoid the capital gains tax, an assessee can either purchase a house within a period of two years after the date on which the transfer took place, construct a house within a period of three years after the date of transfer, or should have purchased a house one year before date of transfer. In these cases, instead of the capital gains being charged to income tax as income of the previous year in which the transfer took place, will be dealt with in accordance with two provisions.

One, in case the capital gains is more than the cost of the house purchased or constructed, the difference will be charged as income of the previous year. In case the new house is sold within a period of three years of its purchase or construction, for the purpose of computing capital gains in respect of the new asset, the cost will be zero.

Two, in case the capital gains is equal to or less than the cost of the new asset, it is not charged to tax at all. In case the new house is sold within a period of three years of its purchase or construction, for the purpose of computing capital gains in respect of the new asset, the cost will be reduced by the amount of the capital gains.

The part of capital gains not appropriated by the assessee towards the purchase of a new house made within one year before the date of transfer of the original asset, or which is not used by him for purchase or construction of a new house before the date of furnishing the returns of income, should be deposited by him in specified bank. The amount should be deposited before the due date for filing income tax returns.

The proof of this deposit should be attached with the income tax return. The amount used by the assessee to purchase or construct a new house together with the amount deposited will be deemed to be the cost of the new house. In case the amount deposited is not used in full for the purchase or construction of the new house within the period specified, the unused amount is charged as income of the previous year in which the period of three years from the date of the transfer of the original house expires. The assessee will be entitled to withdraw the amount in accordance with the provisions of the scheme.

This benefit is available only for individuals and Hindu Undivided Families (HUF).