The Capital Gains Account Scheme Offers Tax Savings for House Buyers
Within the realm of tax planning, there exists a valuable technique that enables you to reinvest your capital gains while avoiding the payment of long-term capital gains (LTCG) tax. This method, subject to certain conditions, allows you to redirect your gains into the purchase of a house or capital gains bonds.
If you have aspirations of acquiring a house in the near future, this tax strategy can be particularly beneficial. It allows you to safeguard the taxable gains obtained from the sale of assets such as stocks, bonds, debt or equity mutual funds, and even precious metals like gold or diamond jewelry. The process involves transferring these gains into a specialized account known as the Capital Gains Account Scheme (CGAS), thereby potentially reducing your tax liability by a significant margin, typically ranging from 10% to 20%.
However, it’s important to note that not all gains can be sheltered within a CGAS. Only LTCG derived from the sale of the aforementioned assets can be utilized in this manner. Furthermore, for your gains to qualify as long-term, you must hold listed shares and equity mutual funds for a minimum of 12 months before selling them. In the case of unlisted and foreign shares, a holding period of at least two years is required before the gains can be classified as LTCG. As for gains from the sale of debt mutual funds, gold, and diamond jewelry, they attain long-term status only after a holding period of three years.
The Rules for Tax Savings
To avail the benefit of avoiding LTCG tax on gains transferred to a CGAS, you must utilize the amount for purchasing a house within two years of accruing the gains, or three years if the goal is to construct a house.
According to Karan Batra, managing partner at CharteredClub.com, a taxation advisory, “The new immovable property needs to be purchased within two years from the sale of capital assets. If you are constructing a house, then three years are permitted to utilize the capital gains balance.”
An Illustrative Example
Consider the case of an entrepreneur based in Hyderabad who had sold shares of his company, amassing a substantial sum of Rs 32 crore. He wisely parked the entire proceeds in a CGAS and, a year later, acquired a house for Rs 25 crore. As a result of this strategic move, only the remaining amount of Rs 7 crore was subject to taxation, in contrast to the entire Rs 32 crore.
The Requirement to Park the Entire Amount
It’s crucial to understand that if you’ve made a gain of, for instance, Rs 80,000 on an investment of Rs 1 lakh in stocks or a debt mutual fund, you are obliged to deposit the entire sum of Rs 1.8 lakh (comprising both principal and gains) into a capital gains account held with a bank. Paras Savla, Tax Partner at KPB & Associates, a chartered accountancy firm, emphasizes, “One cannot just invest the gains made from the sale of the capital asset. The whole consideration has to be parked in the special account.”
Flexibility in Asset Types
This strategy allows for the utilization of gains from the sale of both Indian and foreign shares, including unlisted shares, to build a corpus within the CGAS scheme. At the end of the stipulated period, the accumulated amount can be employed to purchase or construct a house by following the necessary procedural steps.
Compliance with Conditions
To benefit from the Capital Gains Account Scheme, it’s essential to adhere to the conditions outlined in the Income Tax Act of 1961. On the day of selling shares or mutual fund units, you should not own more than one house property, and the amount must be used specifically for acquiring a residential property, not land or commercial property.
Meeting Deadlines for Tax Returns
Furthermore, it’s imperative to consider the deadline for filing income tax returns in order to utilize the accrued amount effectively. For instance, if you sold an asset in September 2022, and your two-year period concludes in September 2024, you must reinvest the gains and proceeds before filing your returns in 2024. This implies that you need to reinvest by July 31, 2024 (for non-audited accounts), rather than waiting until March 31, 2025.
Maintaining the House
Lastly, it’s important to note that if you’ve saved on taxes by reinvesting in a house, you cannot sell the property within three years. Section 54 (F) of the Act stipulates that you must retain ownership of the house for a minimum of three years. Failure to do so will result in the reversal of the entire tax benefit, necessitating the payment of taxes, penalties, and interest on the LTCG from the sale date.
Navigating Joint Ownership for House Purchases
In situations where you and your spouse jointly own shares or mutual funds, but both of you intend to reinvest the capital gains in separate houses, there is no adverse impact on the taxation associated with house purchases. Tax planning can be structured to optimize savings in such scenarios, as illustrated by a fitness chain operator who, along with his spouse, successfully executed a tax-efficient strategy when purchasing their dream homes.
Considering Other Tax-Saving Options
While the utilization of capital gains for house purchases offers significant tax benefits, it’s essential to explore other avenues for tax savings as well. For example, individuals with investments in fixed deposits (FD) who don’t require immediate access to those funds can consider reallocating them to liquid mutual funds. By doing so, they can benefit from the tax advantage associated with capital gains, as income from liquid funds is treated as capital gains and can be directed towards the CGAS. This approach provides an alternative route for tax-efficient financial planning.