Timing is critical in finance, especially if you want to make a profit. Of course, you need to pick a good time to take advantage of the appreciation in value, but it's equally important to keep an eye on the calendar to avoid paying a hefty amount as tax. It was a lesson learnt well by Mumbai-based Benny Abraham when he sold his house in 2011 within two years of purchasing it. The property was fetching me nearly 60% in profits on the initial investment, so when I got an offer to sell it, I immediately agreed.

Unfortunately, the 50-year-old had no clue about the tax implication of his hasty decision. Not only did he have to pay a substantial amount as tax on the profit, he also had to shell out the tax exemptions that he was availing of on the home loan.

This is because under the Income Tax Act, if you sell a house within three years of buying it, the tax benefits on the principal repayment and interest paid on the home loan are reversed. These are then included in your income when you file your tax return. Also, if a house is sold within five years of the end of the financial year in which it was purchased, all the deductions claimed under Section 80C with respect to the property are added to the taxable income in the year of sale.

Capital gain and indexation

Real estate is regarded as an asset, so the profit from its sale is assessed under the head 'capital gains'. If a property is sold within three years of buying it, it is treated as a short-term capital gain. This is added to the total income and taxed according to the slab rate. However, if you sell a property after three years from the date of purchase, the profit is treated as a long-term capital gain and is taxed at 20% after indexation. While you can avail of various tax exemptions in case of long-term capital gains, no such benefit is provided for short-term ones.

One of the advantages associated with long-term capital gains is the inclusion of indexation while determining the profit. Indexation is a method through which the seller is able to inflate the value of his assets. Since inflation reduces the value of an asset over time, it is essential to increase the initial cost of the house to calculate its current value. This is done by multiplying the original cost price with a factor that is issued by the Central Board of Direct Taxes. This factor tracks the increase in the general price level, or inflation, and is known as the cost inflation index (CII). It is notified by the central government for every financial year. The Income Tax Act considers 1981-82 as the base year with a cost inflation index of 100. So, the CII for 1982-83 is 109, and so on.

The indexed purchase price can be calculated as—purchase price x (CII for year of sale / CII for year of purchase).

The indexation of purchase price helps to reduce the net capital gain, thereby slashing the tax burden for the seller.

Reduce your tax burden

You can claim tax exemption under Section 54 on the long-term capital gain on the sale of a house. "To avail of this exemption, you must use the entire profit to either buy another house within two years or construct one in three years. If you had already bought a second house within a year before selling the first one, you could still avail of the tax exemption.

 
Such capital gain exemption is reversed and the amount taxed as capital gain if the new property is sold within three years of the date of purchase/construction. This profit will be considered a short-term gain and taxed at the normal slab rates, not the 20% beneficial rate.

 
You can also utilise Section 54 (F) to avail of exemption on the long term capital gain made from the sale of any asset other than a house. Again, the sale proceeds should be invested only in a residential property, not a commercial property or a vacant plot of land. However, to avail of this benefit, you should not own more than one house.
The long-term capital gain tax can also be saved under Section 54 (EC) if the capital gain is invested for three years in bonds of the National Highways Authority of India and Rural Electrification Corporation Limited within six months of selling the house. However, you can invest only up to 50 lakh in a financial year.

The sale proceeds will be calculated on the basis of the valuation adopted by the state's Stamp Duty and Registration Authority and will not be the amount mentioned in the deed of conveyance. This is intended to cover the cases where a portion of the sale price is received by the seller as unaccounted for cash.

If you miss the due date

It's possible that you are not able to make the required investment to avail of the exemption on capital gains before the due date for filing your tax return. In such a situation, the amount of capital gain or net consideration, as the case may be, has to be deposited in a separate account in a nationalised bank under the Capital Gains Account Scheme (CGAS) before the last date of filing your return for the relevant year. There are two types of such accounts—type A is a savings deposit and type B is a term deposit. The interest rates for these are the same as those for regular savings and term bank deposits. The proof of the deposit can be attached along with the tax return in order to claim exemption.