Gains arising out of the sale of capital assets are known as Capital Gains, which are taxable under the Income Tax Act. However, the Central Government has introduced various exemptions and deductions that allow the assessee to benefit from tax relief on capital gains, provided they meet specific conditions and circumstances, thereby optimising their tax liability.
Under the Income Tax Act, 1961, the interest earned by an individual through an asset whose net worth has increased over a period of time is eligible for capital gain exemption after factoring the indexed cost of acquisition and inflation.
Capital gain is the increase in value of an asset that gives the asset a higher worth than the purchase price. The capital gain can be short term or long term. Long term capital gains are usually taxed at a lower rate.
For instance, Sheetal bought a house in the year 2004 for Rs.50 lakhs. The value of the house stands at Rs.1.5 crore. And since the property was held for over 3 years, the gain will be a long-term capital gain. The cost price of the house is adjusted according to the inflation and indexed cost of acquisition. After the cost of acquisition is indexed, the adjusted cost of the house will be Rs.1.06 crore, the net capital gain will be Rs.44 lakhs. Long term capital gain is taxed at 20 percent and for the net capital gain of Rs.44 lakhs, Sheetal will have to pay Rs.8,80,000 towards tax. However, this tax outgo can be lowered by taking the benefits of exemption provided by the Income Tax Act, 1961.
List of Exemptions Under Capital Gain
Capital Gains Exemption/Deduction | Asset Type | Exemption Amount | Applicability |
Exemption under Section 54 of the Income Tax Act | Gains on sale of residential property | The cost of the new asset or Long term capital gains whichever is lesser, but the exemption amount is up to ₹10 crore. | Assessee can be Individual or HUF |
Exemption under Section 54B of the IT Act | Gains on sale or transfer of land for agricultural purpose | Cost of the new asset or long term capital gain whichever is lesser | Assessee can be Individual and HUFs, it is applicable for both LTCG and STCG |
Exemption under Section 54D | Profit on mandatory acquisition of land and building for industrial undertaking | Cost of the new asset or long-term capital gains whichever is lower. | Any assessee is applicable |
Exemption under Section 54EC | Gain from certain types of bond investments | Exemption Amount = Cost of new asset x Capital Gain / Net Consideration (the maximum limit is capped to the amount of capital gains) | Any assessee can avail this benefit; applicable for an LTCG |
Exemption under Section 54EE | Profit from investments in a unit of a specific fund | Exemption Amount = Cost of new asset x Capital Gain / Net consideration (the maximum limit is capped to the amount of capital gain) | Any assessee can avail; applicable only for LTCG |
Exemption under Sections 54G and 54GA | Gain from investment in a residential house | Cost of a new asset or long-term capital gain, whichever is lesser | Any assessee can avail this benefit; it is applicable for both STCG and LTCG |
Exemptions under Short Term Capital Gains
Short term capital gain arising on transfer of agricultural land (Section 54B):The capital gain earned here will have to be reinvested in the purchase of agricultural land. The same exemption is allowed for long term capital gain as well. The land must be purchased 2 years from the date of sale or transfer. If the capital gain is higher than that of the purchase value of the new agricultural land, then the remaining balance will be taxed. If the gain is less than the purchase price of the new agricultural land, then no tax will be charged.
Exemptions under Long Term Capital Gains
Profit on sale of residential house (Section 54):
If the house is sold for residential accommodation, if it is self-occupied or rented out, you can avail full exemption, provided:
- The assessee must be an individual or Hindu Undivided Family.
- The assessee has held the house for more than 3 years.
- The assessee has purchased a new house one year prior to the sale or two years after the sale of original house or if he is constructing a new house within a period of 3 years after the sale of original house.
- If the amount is deposited in a bank under the Capital Gains 1988 account scheme.
- If the cost of the new house is equal to or more than the capital gain earned.
- If the new house is sold within 3 years from the date of purchase or construction, then the cost of the new house is deducted by the amount of capital gain exempted on the original house and the difference in the sale price of the new house will be treated as a short-term capital gain.
If the capital gain is invested in long term specified assets of NHAI or Rural Electrification Corporation (Section 54EC):
It is subject to the following:
- The profit earned is from the sale of a long-term capital asset.
- The assessee must invest a part of the capital gain or the whole of the gain in specified assets like bonds of NHAI or REC that have a 3-year lock-in period, 6 months from the date of sale of the original asset.
- The investment made should not be less than the capital gain. If a part of the gain is invested, then the proportionate amount will be exempted while the balance amount will be taxable.
- Assessee must retain the new asset for a minimum of 3 years.
Profits from the sale of an asset other than a residential house is used to buy a residential house (Section 54F):
This is subject to the following conditions:
- The assessee must be an individual or a Hindu Undivided Family.
- The capital gain should be from a sale of an asset that is not a residential house.
- The assessee has bought a new house one year before the sale of the asset or two years from the sale. He can also construct a house within 3 years from the sale of the original asset.
- The cost of the new house must not be less than the value of the asset sold. If a part of the capital gain is invested, then only that part will be exempt, the balance amount will be taxable.
- If the full amount is not invested to either buy a house or construct it, then it should be kept in the bank under Capital Gains Scheme 1988 account. The amount in that account should be utilized for constructing a house or to buy a new house.
- On the date the assessee is selling the original capital asset, he must not own more than one residential house apart from the new house. He must also not buy another house in 2 years or construct a new house from 3 years of buying or constructing the new house.
Other Exemptions
- Section 54D: Exemption is allowed for gain arising from industrial land or building that has been acquired by the government. The asset should’ve been used for industrial purpose for a period of 2 years prior to the acquisition. The exemption is allowed only if the gain will be reinvested to acquire land or building for industrial purpose.
- Section 54G: Exemption is allowed on the gain arising from the transfer of land or building or a machinery to shift an urban undertaking to a rural area. The exemption is allowed provided the gain is reinvested to acquire land, building or machinery in a rural area.
- Section 54GA: Exemption is allowed on the gain arising from the transfer of land, building or machinery to shift from urban area to Special Economic Zone provided the gain is reinvested to acquire land, building or machinery in the Special Economic Zone.
- Section 54GB: Exemption is allowed on the long term capital gain arising from the sale of residential property 31 March 2017. The capital gain must be utilized to subscribe to equity shares in an eligible company.
FAQs
What happens if I fail to reinvest the capital gains?
If you fail to reinvest the capital gains within the stipulated time, the exemption will be revoked, and you will need to pay capital gains tax on the amount.
Can NRIs claim capital gains exemption?
Yes, Non-Resident Indians (NRIs) can also claim capital gains exemption under sections like Section 54 and Section 54EC, provided they invest in assets located in India.
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