How to make your real estate investments completely “Tax Free”
There are two types of income that you can generate – Earned income & passive income.
To generate earned income you have to work (e.g income form salary), but to generate passive income you don’t have to work because it comes from your assets like stocks, bonds, real estate etc.
Out of several advantages of passive income over earned income, one distinct advantage of passive income is that there is lot of scope for tax planning. For example, if you make 1 crore as earned income – lets say salary which is subjected to net 20% to 30% tax rate, you will end up paying 20 lacks to 30 lacks in taxes, but if that 1 crore comes in from of passive income – lets say long term capital gains on shares – tax on that is zero. Similarly, if you make 1 crore by buying & selling real estate, tax that you will end up paying on that can be zero if you do some smart tax planning.
This blog will tell you – how you can make your real estate investments completely tax free.
To begin with, there are few important points that you need to know:
- The profit that you make by buying & selling real estate property is subjected to capital gain tax.
- If such property is held for less than 2 years, profit on selling such real estate property will subjected to short term capital gain tax, wherein the profit will be added to your income and taxed as per your income tax slab.
- On the other hand, if property is held for 2 years or more, profit from selling such property will be subjected to long term capital gain tax which is 20% with indexation benefit.
- However, in this blog you will see – what you can do, to make this profit from buying & selling real estate – completely tax free.
For this, 1st you need to ensure that you hold our real estate investment at least for 2 years. This will ensure that when you sell this property, it will be treated as “Long Term Capital asset” & gains from such long-term assets will be treated as “Long Term Capital Gains”. Then tax on such long-term capital gains can be saved using 1 or more of following 3 sections of the income tax act 1961.
- Section 54
- Sec 54F
- Sec 54EC
- Using section 54:
Under section 54 of the income tax act, tax on long term capital gains from selling a residential property can be saved by reinvesting those gains in another (only one) residential property. But if you are using section 54 to save capital gains tax on profit that you make by buying and selling residential property then you will have to keep following things in mind:
- The new residential property you buy in order to save tax on original property, has to be bought within a period of “1 year before OR 2 years after (3 years after – if new property is under construction)” the date of sale of original property.
- The new residential property so bought should not be sold within 2 years, otherwise while calculating short term capital gains on new property, the capital gain saved earlier will be reduced from the cost of new property i.e effectively capital gain saved under sec 54 will become taxable again.
So, if you take care of above 2 points then you can use Sec 54 to save capital gain tax on the profit that you make by buying and selling residential property. However, what if the property that you are buying & selling is not a residential property, rather it is a commercial property, then instead of Sec 54 you can use Sec 54F to save capital gain tax on the profit that you make by buying and selling commercial property.
2. Using Sec 54F:
Under section 54F of income tax act, tax on long term capital gains from selling any asset other than residential property can be saved by investing the sales proceeds in a residential property. But again, here you will have to keep following things in mind:
- Unlike section 54 where only capital gains were to be invested, here entire sales proceeds will have to be invested to make capital gain tax liability zero.
- But just like Sec 54, in Sec 54F also – new property is to be bought within a period of “1 year before OR 2 years after (3 years after if new property is under construction)” the date of sale of original property.
- Also, the new property so bought should not be transferred within 2 years, otherwise while calculating taxable short term capital gain on new property, the capital gains saved earlier will be reduced from cost of new property i.e effectively capital gains saved under Sec 54F will become taxable again.
- It’s also important to note that tax exemption under section 54F is available only if the assesse does not own more than one residential house property (exclusively of one he had bought for claiming exemption under sec 54F) on the date of sale of original property on which you want to save tax using section 54F.
In addition to Sec 54 & Sec 54F, there is one more section – Sec 54EC, which you can use to save capital gain tax on both – residential as well as commercial property.
3. Sec 54EC:
Under Sec 54EC of the income tax act, tax on long term capital gains from selling any asset (including residential OR commercial property) can be saved by investing the capital gains in “specified capital gain saving bonds”. However over here also you will have to keep following things in mind:
- The investment in bonds should be made within 6 months of date of transfer of old asset on which you want to save capital gain tax using Sec 54EC.
- Also note that the maximum amount you can invest in these bonds to save capital gains is Rs 50,00,000.
- The investment in bonds should be made for minimum period of 3 years otherwise the the long-term capital gains saved using section 54EC will become taxable again.
Finally, it’s important to note that you can use “1 Or more” of above sections, i.e you can use combination of section “54 & 54EC” OR combination of section “54F & 54EC” to ensure you end up paying minimum amount of tax and most of the time even zero in taxes.