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Having invested heavily in a real estate asset or an immovable property to receive lucrative returns is a seasoned investor’s wishful thinking and in fact, when it gets true, paying a large chunk of the amount to the tax is a pain that we all as an investor have to go through.
We badly want to save the tax but fail at doing it wisely, let’s explore Capital Gain Bonds which are otherwise called 54 EC Bonds in this case.
How 54EC Bonds or Capital Gain Bonds can be a savior?
On a more precise note, one must understand, the tax that you can save through this investment is for long-term capital gains and not short-term capital gains.
So the gains or the profits you made must be over a minimum limit to consider it to be long-term gains. Let’s understand each crucial aspect of this in a better way!
What are long-term capital gains and what are not?
Any gains made from the sale of a property or land are called Capital Gains as it is a Capital Assets. It depends on the holding time of the asset to consider it a long-term or short-term gain.
If the property is sold after 2 years, it comes under the long-term capital gain. And any holding period below 2 years is considered a short-term gain.
And in regards to the tax, any money generated after the sale of the property is considered as “Income”. For any income generated, we are liable to pay tax, so the tax paid for this specific income is called Capital Gain Tax.
If it is a short-term capital gain, the investor has to pay as per their income tax. In the case of the long-term capital gain, it attracts 20.6 percent tax plus the cess and surcharge with the indexation benefit.
The point to be noted is that if the property is inherited or is a gift, as it doesn’t involve the purchase, it will not incur capital gain tax but if you decide to sell the inherited or gifted property, then the capital gain tax is applicable as per the holding period.
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What choices are you left with?
In order to save your long-term capital gain tax or LTCG through the fixed-income market, let’s look into these options.
1. Pay the long-term capital gain tax (LTCG)
Let’s imagine that you have to pay the incurred tax. Assuming you have capital gains of Rs 40 lakhs after selling a property. On the indexed profits of Rs 15,83,941, you need to pay a tax of 20.6% which is up to Rs 3,26,292 have to be paid as tax.
This is straightforward to comprehend. But since you are here to save tax, this isn’t the option you need to look at rather at the other options below.
2. Reinvest in other property or construct a house
Assuming this time you are reinvesting the profits in another property or trying to reconstruct, imagine the construction cost, maintenance cost, and interior cost when you are constructing and in case of buying a brand new property, it might sound much easier than constructing but still asks you to hunt for a property or land that meets your criteria is just a big task in itself.
But what if you are not looking at buying or constructing with this money, you might consider the next option that is available to you.
The insightful information of this option is that under Section 54, you can exempt taxes on the capital gains you made by reinvesting in buying or constructing, but only once by ensuring the capital gains don’t exceed Rs 2 crores.
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3. Invest in 54 EC or Capital Gain Bonds
When it comes to 54 EC Bonds the maximum investment is Rs 50 lakhs and investment in this instrument must be done before 6 months of the property sale and not after that. The property can either be residential or commercial for that matter.
As long as you are not looking to use this money immediately up until 5 years, you are great with this as it has a lock-in period of 5 years. And you can’t sell it anytime before the maturity date.
Currently, bonds from the National Highways Authority of India (NHAI), Rural Electrification Corporation (REC), Indian Railway Finance Corporation (IRFC) Limited bonds, Power Finance Corporation Limited (PFC) bonds, and Central Governments are offering these bonds to you.
You can start with as low as 10,000 to invest in these bonds and in case the property is held jointly by multiple individuals then each individual gets the leverage to invest Rs 50 lakhs in 54 EC Bonds.
If you wonder how these bonds are backed, then the governments are behind this and possess a rating that is highest from the rating agencies like CARE, CRISIL, and ICRA. The average interest offered in these bonds is 5%.
Another point to consider in this investment is the interest income is taxable as per the income tax be it 10%, 20%, or 30% slab rate. With your preference, you can buy the bonds in a physical form or online, that’s up to you.
Let’s imagine you are investing your profits in this bond of Rs 40,00,000 and you bought it at Rs 10,00,000 on 1st May 2008 (FY 2008-09) and sold it on 9th November 2023 (FY 2023-24).
Before we begin with calculating the tax exemption, the long-term capital gains come with indexation benefits and we need to find the Indexed Cost of Acquisition.
In order to find the Indexed Cost of Acquisition, Capital Inflation Index is needed, and this is how we can arrive at it:
Indexed Cost of Acquisition (Purchase cost/CII of the year of purchase)*CII of the year of sale
The indexed cost of the acquisition is:
(1000000/137)*331 = Rs 24,16,058/-
Here the Cost Inflation Index for FY 2008 – 2009 is 137 and the Cost Inflation Index for FY 2023 – 2024 is 331.
Rs 24,16,058/- is the cost that we need to use to calculate the Capital gain tax on the profits made by selling the property.
The next thing to do is to find the Capital Gain Tax, which can be found by deducting the Indexed Cost of Acquisition from the Actual Sale Price.
As per our example, the sale price was Rs 40 lakh and the arrived Indexed cost of acquisition was Rs 24,16,058. With that the Capital Gain will be Rs 15,83,941/- ( ₹ 40 lakh- ₹ 24.16 lakh)
Rs 15,83,941/- this amount is the gain considering the indexation, which will be liable to long-term capital gain tax of 20.6% + Surcharge if you are paying. But it can be exempted if you invest in Capital Gain Bonds.
So when you invest Rs 15,83,941/- in Capital Gain Bond, the tax is anyway exempted which will be nil. On investing you’ll receive an interest of 5% per annum for 5 years, also assuming that you would reinvest the interest in the investment, it would give a compounded interest income each year.
But as conveyed that the interest income is liable to income tax as per the slab rate, the post-tax interest income will be as follows.
Cashflows after 5 years if: 10% tax bracket 20% tax bracket 30% tax bracket
54EC Bonds @5% 1,977,793 1,934,032 1,890,271
This is how your returns look like on the investment in Capital Gain Bonds with tax exemption.
4. Pay the LTCG and the remaining amount in the bonds with a return of 8% and more
The last option that one could do is to pay the LTCG of Rs 3,26,292 and put the remaining profits of Rs 12,57,649 in high-interest rate bonds such as 8%, 10%, 11% & 12%
Continuing with the same example, and on investing Rs 12,57,649 in high-interest rate bonds, this is what it comes out to.
Cashflows after 5 years if: 10% tax bracket 20% tax bracket 30% tax bracket
Invests @ 8% 1,788,874 1,729,849 1,670,824
Invests @ 10% 1,948,676 1,871,895 1,795,114
Invests @ 11% 2,005,342 1,922,265 1,839,188
Invests @ 12% 2,120,531 2,024,656 1,928,780
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Wrapping up
We have put across the options you can opt for, it’s up to you to make a better analogy to invest in the one that suits you.
In line with the investment choices, Capital Gain Bonds make absolute sense to get interest on the profits you earned while also nullifying the tax it could have incurred than paying the tax directly with no extra interest income or investing in the high-interest bonds by taking higher risk. Or having to hunt for a new property or land or even be involved in the hassles of construction.
Additional Note:
Please note that there has been a recent change in the taxation of real estate under the long-term capital gains (LTCG) regime. The government has introduced an amendment allowing taxpayers to choose between two tax options for properties acquired before July 23, 2024:
- A lower rate of 12.5% without indexation.
- A higher rate of 20% with indexation.
Taxpayers can calculate their tax liability under both schemes and opt for the one that results in a lower tax payment. This update may impact your tax planning and investment decisions.
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