The Budget has dealt a blow to property owners by removing the indexation benefit. Previously, sellers could adjust the purchase price of a property for inflation, which would significantly reduce capital gains tax.
The silver lining, however, is that the long-term capital gain (LTCG) tax has been reduced to 12.5% from 20% earlier. But, those who have sold a property in the last three years can get the best of both worlds–removal of indexation as well as the lower 12.5% tax rate–thanks to a loophole in section 54 of the Income Tax Act.
Understanding section 54
Section 54 says a seller can use the capital gains made from the property sale to buy or construct a new house. This exempts the seller from paying tax on the gains made on the sold property. The condition is that the new purchase should be done within two years, or three years if constructing the house. But, this doesn’t mean you can leave the gains in the bank account till you don’t find the house to reinvest in.
This is because the tax on capital gains is to be paid for the year in which the property is sold. So, if the gains are in your bank account at the time of filing Income Tax Return (ITR) for the year in which you sold the property, you will have to pay tax.
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To avoid this, the government gives you the option to deposit the gains in Capital Gains Accounts Scheme (CGAS) till the time you finalise the house to reinvest the capital gains. The money can be withdrawn from CGAS within the specified timeline to purchase a property.
It is in CGAS where property owners who sold the property before 23 July, the date when the removal of indexation on property became effective, can get the benefit of both indexation and 12.5% tax rate.
It’s a loophole that was not addressed in the Budget.
Here is how it works
Say, a person sold a house in May 2024 and has not used the gains yet. Since the property was sold before 23 July, the seller will get indexation benefit to calculate the capital gains. To avail the lower 12.5% tax rate, they can deposit the capital gains in CGAS and withdraw them in or after FY25-26. The ITR utility for FY25-26 and thereafter will calculate long-term capital gains at the default rate of 12.5%, which means the seller in the above example will not have to pay 20% tax.
“The government has not made the consequential amendments in section 54, as a result of which atax saving opportunity has arisen for some property sellers,” said Karan Batra, founder, charteredclub.com.
If the government doesn’t plug this loophole, this may also work for those who already have capital gains from property lying in the CGAS account and don’t find a house to reinvest in within the stipulated timeline.
When the two-year window expires and the taxpayer doesn’t use the funds parked in CGAS to purchase another property, the untilised funds are taxed as long term gains in the same financial year. As per the Budget, tax rate of 12.5% is effective 23 July 2024, which means unutilized withdrawals from CGAS account post the said date will be taxed at 12.5%.
In fact, a taxpayer who sold a house in FY2023-24 and has not used the gains yet and is yet to file IT returns (ITR) may also deposit the gains in CGAS to make the workaround work for them.
Sellers get time till 31 July, the due date of filing ITR, to deposit gains in CGAS. So, sellers from the previous financial year have four days to make the deposit if they are still holding on to the gains and are undecided whether to pay tax on them or buy another house under section 54.
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