The transfer (or sale) of residential property is subject to taxes in India. The profit (Sale price less purchase cost) is called as Capital Gain. If the residential property such as a house, villa or flat is owned/held for more than 24 months by the owner, it is called as Long Term Capital Gain (LTCG). The tax on such LTCG can be saved/reduced by reinvesting the Capital Gain in another residential house property as per Section 54 of the Income Tax Act.
The changes proposed in Budget 2023 can be better explained through an example – Suppose Mr Dhananjaya sells a house at RMV Extension for Rs.15 Crores that he had purchased in 1997 at a cost (indexed) of Rs.1 Crore. Thus, he made an LTCG of Rs.14 Crores.
- If the said sale is made on or before 31st March 2023 – He can invest Rs.14 Crore in a villa, thereby his entire gain is reinvested; consequently, he won’t pay any taxes (which means he pays ZERO tax on the sale)
- Changes in Budget 2023 – If he invests Rs.14 Crore in a villa, he will get a deduction of up to Rs.10 crore, and the balance of Rs.4 Crore is taxable as LTCG. So, the maximum reinvestment deduction benefit is restricted to Rs.10 Crore.
Why were the budget amendments made to limit the reinvestment deduction benefit to a maximum of Rs.10 Crore?
The objective behind giving tax exemption on reinvestment was to encourage people to buy or build houses for their own use. However, the Government has observed that high-net-worth individuals claim huge deductions by purchasing very expensive residential houses. It defeats the very purpose of the reinvestment benefit. So, the Budget capped the maximum deductions to Rs.10 Crores.
Identical modifications are done in Section 54F to limit the LTCG reinvestment benefit to Rs.10 Crores from the sale of other long-term capital assets (like commercial property, plots, etc.).
Clarification on deduction of Interest on Housing Loan
As you are aware, the interest paid on a housing loan can be deducted from the income from the house property. In addition, while computing the capital gain on the sale of the property, many taxpayers were adding the housing loan interest paid as a cost of purchase/improvement of the property. Thereby, interest is claimed as a deduction twice!
In order to prevent this double deduction, it is clarified in the Budget 2023 that the cost of improvement while computing capital gain shall not include interest claimed under House Property income.
I will write more in the next short note.
Pls suggest if LTCG tax can be saved/ reduced by reinvesting the Capital Gain in any other instruments instead of buying another residential house property.