How to Avoid Tax on Long-Term Capital Gains?

The Union Government revised capital gains tax rates through announcements in Budget 2024. Long-term capital gains on the sale of any capital asset shall be taxed at 12.5% without indexation.

As with any change, certain categories of investments (foreign equity/ gold MFs) benefited while the others (stocks and mutual funds) lost marginally.

However, the biggest source of discontent came for the real estate investments, where the removal of the indexation benefit suddenly increased the notional tax liability for many investors, who owned non-performing real estate assets. The indexation benefit has been restored for real estate properties bought before July 23, 2024. For properties bought before July 23, 2024, the seller would have a choice to pay gains at 20% after indexation or 12.5% without indexation. No indexation benefit for property bought on or after July 23, 2024.

While the Government has tinkered with holding periods and tax rates, it has not made any changes to various IT sections, where you can seek relief and avoid paying taxes on long-term capital gains. If these tax changes are bothering you, you can seek relief under one of Sections 54, 54EC, and 54F.

How to avoid taxes on Long Term Capital gains?

There are 3 ways.

1. Section 54: Buy a residential property (only you have sold a house)
2. Section 54F: Buy a residential property (if you have sold any capital asset except house)
3. Section 54EC: Buy capital gains bonds (only if you have sold a property, including house)

These sections offer relief from taxes only on the long-term capital gains. No relief from taxes on short-term capital gains.

Note: I have used “Residential house”, “residential house”, or just “house” interchangeably in this post. Residential House/Residential Property/House is such a property from where the income as “Income from House Property”.

There is another way to avoid paying taxes. That is by booking losses somewhere in your portfolio. This process is called tax-loss harvesting. For more on this topic, please refer to this post. I will NOT discuss tax-loss harvesting in this post.

I present a summary about tax relief from capital gains taxes in the following table.

#1 Section 54 (Sold a house, Bought a house)

OLD/SOLD asset: Residential property/house

NEW Asset (to be bought): Residential property/house

Pre-conditions and Timelines

1. The house must be purchased or built in India.
2. You MUST PURCHASE a residential house within a period of 1 year before or 2 years after the sale of such house (OLD asset); OR
3. You MUST CONSTRUCT a residential house within a period of three years from the date of sale of such house (Old asset).

Any cap on LTCG set-off

You can set off LTCG up to Rs 10 crores under Section 54.

You book LTCG of Rs 12 crores on sale of house.

And you buy a NEW house worth Rs 12 crores.

However, the tax benefit will be extended to only Rs 10 crores. On the remaining Rs 2 crores of LTCG, you must pay tax on capital gains.

Point to Note

1. Only LTCG: To save taxes, you need to invest only the Long-term capital gains. Section 54 offers no relief for short-term capital gains.
2. Do not sell the NEW house too soon: If you sell the NEW house (bought to set off capital gains) within 3 years of purchase (completion of construction), the purchase cost of the NEW House shall be considered NIL for determination of capital gains. This is a way to claw back the tax-benefit if you sell the new house too soon.
3. In case the LTCG on sale of OLD house is up to Rs 2 crores, you can buy up to 2 properties and still take benefit under Section 54. However, this option of buying 2 houses (and yet taking benefit under Section 54) can be exercised only once in your lifetime.
4. Capital gains account: If you are unable to purchase (construct) the NEW house within 12 months from sale of OLD house OR before filing returns for the financial year (not later than tax-filing due date), whichever is earlier,  then you must deposit these unutilized gains in Capital gains account. Subsequently, you can withdraw the amount for purchase/construction of house within timelines specified. I will explain this later in this post with the help of an illustration.
5. Claw back of Tax Benefit: If you do not utilize the amount deposited in capital gains account towards purchase/construction of house within timelines, the tax benefit under Section 54 will be clawed back on the unutilized amount. You will have to pay LTCG tax on the unutilized amount.

Illustration

You bought a house for Rs 50 lacs in 2019. You sold the house in 2024 (after July 23, 2024) for Rs 1.25 crores. Say you sold on August 5, 2024.

Long-Term Capital Gain = Rs 1.25 crores – Rs 50 lacs = Rs 75 lacs (assuming 12.5% with no indexation benefit is better)

To avoid paying tax on this gain, you must buy (or construct) a house worth at least 75 lacs within specified timelines.

Case 1

If you buy/construct a house worth Rs 40 lacs, then you avoid paying tax only on Rs 40 lacs.

You will have to pay LTCG tax on the remaining Rs 35 lacs (Rs 75 lacs – Rs 40 lacs).

Case 2

You cannot purchase/construct a house before filing your Income tax return for FY2025 (not later than the due date, which is usually July 31). Note there is another restriction. The unutilized gains must be invested within 1 year of sale of the OLD asset. Hence, the deadline for depositing money in the capital gains account is the earliest of the following dates.

1. 1 year from the date of sale of OLD house/asset (August 5, 2024 + 1 year = August 5, 2025)
2. Actual Date of ITR filing for FY2025
3. Due date for ITR filing for FY2025 (say July 31, 2025)

Assuming you file your ITR return on the last day (July 31, 2025), you must deposit the unutilized amount from this Rs 75 lacs in the capital gains account before filing your ITR for FY2025 (not later than July 31, 2025).

Let us say you have used Rs 10 lacs already for purchase/construction of house. You must deposit the remaining Rs 65 lacs in the Capital gains account.

1. If you do not deposit anything in CG account, you must pay tax on the remaining Rs 65 lacs LTCG while filing ITR for FY2025 (or as advance tax).
2. If you deposit only Rs 50 lacs, then you are telling the Government that the cost of new property will not be more than 60 lacs (50+10). Hence, you must deposit tax on LTCG worth Rs 15 lacs (Rs 75 lacs – Rs 60 lacs) while filing ITR for FY2025.
3. You deposit Rs 50 lacs and utilize the entire amount within specified timelines: No tax liability on LTCG
4. If you deposit Rs 50 lacs but utilize only Rs 30 lacs within specified timelines: Then you must pay tax on the unutilized LTCG of Rs 20 lacs (50 lacs – 30 lacs). Remember, this is over and above tax on LTCG on Rs 15 lacs paid earlier.

#2 Section 54F (Sold any capital asset, Bought a house)

OLD/SOLD Asset: Any capital asset (other than residential property)

You can take benefit under Section 54F on sale of any capital asset (stocks, mutual funds, gold etc.)

NEW Asset: Residential property

Pre-conditions and Timelines

1. The house must be purchased or built in India.
2. You MUST PURCHASE a residential house (NEW asset) within a period of 1 year before or 2 years after the sale of such OLD asset; OR
3. You MUST CONSTRUCT a residential house (NEW asset) within a period of three years from the date of sale of such OLD asset.
4. On the date of sale of the OLD asset, you must not own more than 1 residential house (excluding the NEW house).
5. You must not purchase another residential property (house), apart from the NEW house, within 1 year from the date of sale of OLD asset. If you breach this rule, then the tax benefit taken under Section 54 F will be clawed back.
6. You must not construct another residential property (house), apart from the NEW house, within 3 years from the date of sale of OLD asset. If you breach this rule, then the tax benefit taken under Section 54 F will be clawed back.

Any cap on LTCG set-off

The benefit under Section 54F is linked to investment of the net consideration. Hence, you cannot get away by reinvesting just the capital gains. You must invest the sale proceeds to get benefit under this section.

Section 54F sets the cap for net consideration at Rs 10 crores.

Case 1

You bought stocks for Rs 50 lacs. You sold those stocks for Rs 1.25 crores (net consideration). LTCG of Rs 75 lacs.

If you want to avoid paying tax on the entire Rs 75 lacs, you must invest the entire Rs 1.25 crores into buying a NEW house, subject to meeting other conditions.

If buy a cheaper house, then the exempt capital gains will be reduced proportionately.

Let us say the cost of the NEW house is Rs 90 lacs.

Amount of relief under Section 54F = LTCG * (Cost of New house/Net Consideration)

= Rs 75 lacs * (90 lacs/1.25 crores) = Rs 54 lacs

You will have to pay LTCG tax on Rs 21 lacs (Rs 75 lacs – Rs 54 lacs).

Case 2

You bought stocks for Rs 6 crores. Sold for Rs 15 crores. LTCG of Rs 9 crores.

You bought a NEW house worth Rs 13 crores.

However, Section 54F caps the tax benefit on net consideration of Rs 10 crores.

While you will still get the tax benefit, the benefit will be calculated as if the cost of the NEW house was Rs 10 crores.

Amount of relief under Section 54F = LTCG * (Cost of New house/Net Consideration)

= Rs 9 crores * (10 crores/15 crores) = Rs 6 crores.

Note how Rs 13 crores has been replaced by 10 crores in the numerator.

In this case, only Rs 6 crores will be exempt from tax. The remaining LTCG of Rs 3 crores will be subject to taxes.

Point to Note

1. You must invest the sale consideration (and not just LTCG): This is in sharp contrast to Section 54, where you can seek relief by just investing the capital gains. Here, you must invest the sales proceed to get benefit.
2. Net consideration = Total sale consideration received – Cost incurred in the sale of the asset
3. Do not sell the NEW house too soon: If you sell the NEW house (bought to set off capital gains) within 3 years of purchase (or completion of construction), the tax benefit will be clawed back. Under Section 54, the cost of the New Asset was considered NIL in such cases. However, in Section 54F, there is no such provision. The capital gains amount on which you avoided paying tax by buying the NEW house will be taxed as capital gains.
4. Section 54F does NOT give you option to invest sales proceeds in 2 residential houses
5. Capital gains account: This is the same as for Section 54. Will not repeat here. Unutilized sale proceeds (and not just the capital gains) must be invested in the Capital gains account within 12 months or before filing your taxes for the financial year (not later than the due date), whichever is earlier.
6. If you do not utilize the amounts invested in capital gains account within specified timelines (2 years for purchase and 3 years for construction), the tax benefit will be clawed back.

 #3 Section 54EC (Sold property, Bought capital gains bonds)

OLD/SOLD asset: Property (does not necessarily have to be a residential property)

NEW Asset (to be bought): Capital gains bonds

What are Capital Gains Bonds?

NHAI and REC are permitted to issue capital gains bonds. These bonds have maturity of 5 years.

The current rate of interest is 5.25% per annum. The interest income is taxable.

Pre-conditions and Timelines

1. You must invest the long-term gains in the capital gains bond within 6 months from the date of sale of OLD asset/property.
2. You cannot sell these capital gains bonds until maturity (5 years). If you sell before maturity, the tax benefit will be clawed back.
3. You cannot monetize these bonds in any manner. Even if you take loan against these bonds, the tax benefit taken will be clawed back.

Any cap on LTCG set-off

You can set off LTCG only up to Rs 50 lacs by investing in capital gains bonds under Section 54EC.

Illustration

Cost of property: Rs 40 lacs. Bought in 2019.

Sold for Rs 1.2 crores (on August 5, 2024)

LTCG = Rs 1.2 crores – Rs 40 lacs = Rs 80 lacs (assuming 12.5% without indexation is better).

You invest Rs 50 lacs in capital gains bonds. Even if you invest more, the tax relief will be capped at 50 lacs.

Exempt LTCG = 50 lacs

Taxable LTCG = Rs 80 lacs – Rs 50 lacs = Rs 30 lacs

Can I seek relief under more than one Section?

As I see, there is no restriction on claiming relief under more than 1 section.

However, as we have seen above, the OLD asset (sold) must be eligible for relief under two sections.

Section 54: OLD asset must be a residential property

Section 54F: OLD asset can be any asset expect residential house

Section 54EC: OLD asset be any property, but not necessarily a residential property.

So, if you have sold a residential house, you can claim relief under both Section 54 and Section 54EC.

Alternative, if you have sold a commercial property, you can claim relief under both Section 54F and 54 EC.

Do consider the cost of saving taxes

When you buy a house, you must also pay stamp duty. Stamp duty is a state subject and will vary across states. This is an additional cost to you. Buying a house may involve other costs such as brokerage too. Let us say this total additional cost is 7% of the cost of the New house.

Now, if you are buying a house just to save taxes (and not because you want to stay there or because you see the house as a good investment), you might want to rethink your decision considering these costs.

You may not want to buy a house worth Rs 1 crore (before stamp duty and costs) just to save tax on LTCG worth Rs 5 lacs.

The capital gains bonds (Section 54EC) have no additional cost of investment, but you must consider the low and taxable interest rate offered on these bonds. Hence, while you save tax on LTCG by investing in these bonds, you must appreciate the opportunity cost. However, if you are not an extremely aggressive investor and are willing to consider these bonds as part of your fixed income portfolio, the capital gains bonds seem a good option to me after considering the taxes saved on LTCG.

LTCG on sale of house is Rs 30 lacs. If you invest Rs 30 lacs in capital gains bonds, you earn 5.25% p.a. on these bonds. The interest is taxable.

If you do not invest in these bonds, you pay 12.5% tax. Rs 3.75 lacs. The remaining Rs 26.25 lacs can be invested as per your choice.

Disclaimer: Income Tax rules are complicated and are supposed to be complicated to cover all scenarios and provide exemptions. While I have written this post to the best of my understanding, I am not a tax expert. My knowledge may be incomplete. You are advised to consult a Chartered Account before taking any action based on the contents on this post.

Disclaimer: Registration granted by SEBI, membership of BASL, and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors. Investment in securities market is subject to market risks. Read all the related documents carefully before investing.

This post is for education purpose alone and is NOT investment advice. This is not a recommendation to invest or NOT invest in any product. The securities, instruments, or indices quoted are for illustration only and are not recommendatory. My views may be biased, and I may choose not to focus on aspects that you consider important. Your financial goals may be different. You may have a different risk profile. You may be in a different life stage than I am in. Hence, you must NOT base your investment decisions based on my writings. There is no one-size-fits-all solution in investments. What may be a good investment for certain investors may NOT be good for others. And vice versa. Therefore, read and understand the product terms and conditions and consider your risk profile, requirements, and suitability before investing in any investment product or following an investment approach.