De-Tax. Sold your house? Now, invest to save on tax

Recently, the interest rate on Section 54 EC bonds – popularly known as capital gains bonds – was cut from 5.75 per cent to 5 per cent per annum. This rate reduction is in line with the overall downward interest rate trend in the economy. The new rate (5 per cent) is applicable from August 1, 2020 for investments made in FY 2020-21, that is, until March 2021. For investments received until July 31, 2020, the earlier rate of 5.75 per cent at investment will hold till maturity. The rate could change again in FY2022, that is, from April 2021, depending on interest rates in the economy then.

Despite the rate cut, the capital gains bonds are a good bet for those looking to save tax on long-term gains from the sale of their house or property. Here’s how.

Tax-saver

If you plan to sell your house or a plot of land, plan it such that you have a tax-efficient sale. To start with, sell the property only after at least two years from acquisition. This will qualify the gains as long-term and get you the benefit of lower tax — 20 per cent with indexation benefit. If you sell within two years, the gains will be considered short-term and taxed as per your slab rate.

Even the 20 per cent tax (after indexation) on the long-term gains can be avoided if you invest the gain in another residential house or in specified bonds under Section 54EC of the Income-Tax Act. If you don’t plan to buy another property, invest the gains in these bonds specified by the government.

These bonds are issued by four public sector entities — National Highways Authority of India (NHAI), Rural Electrification Corporation (REC), Power Finance Corporation (PFC) and Indian Railway Finance Corporation (IRFC).

The tax break under Section 54EC is available to the extent of the capital gains you invest. So, it makes sense to invest the entire gains to avoid the tax completely. But there is a monetary limit on how much you can invest. You can deploy a maximum of ₹50 lakh in these bonds, and must do so within six months from the property sale.

This limit of ₹50 lakh is an aggregate limit across the financial year of the property sale and the next financial year. In case of sale of jointly-owned properties, the limit of ₹50 lakh applies to each joint owner.

Earlier, the tax benefit under Section 54EC was available on reinvestment of long-term gain on sale of any capital asset. But Budget 2018 brought about two important changes. One, it restricted the benefit to long-term gains from sale of only land or building or both. Also, the tenure of the specified bonds was increased from three years to five years.

High safety, effective returns

The Section 54EC bonds being issued by the four government-run entities have been rated AAA, indicating the highest level of safety.

The annual interest rate at the time of investment (5 per cent currently for FY 2020-21) stays till the maturity of the bonds and the interest is paid out once every year. The interest payment date differs – NHAI pays interest on its bonds in April, REC pays in June, PFC pays in July and IRFC pays in October. The principal amount is returned on maturity at the end of five years.

The interest payment is taxable but there is no tax deduction at source. The annual interest rate of 5 per cent may seem low compared to what other fixed income investment options in the market currently offer. But the savings on capital gains tax can add significantly to the effective returns of Section 54EC bonds.

The minimum investment in the NHAI issue is ₹10,000 (one bond), while it is ₹20,000 (two bonds) in the other three issues. The maximum investment is 500 bonds (₹50 lakh).

Ifs and buts

They are useful but Section 54EC bonds come with some restrictions. The bonds are non-transferable, non-marketable and non-negotiable. Given that the bonds cannot be transferred, they are also not listed on any stock exchange. In effect, the bonds have a lock-in of five years. Also, the bonds cannot be offered as security for any loan or advance.

In case the investor transfers the bonds or converts them into money before five years, the capital gains exempted from tax earlier will be reversed. Also, if the investor uses the bonds as security to get loans or advances, it will be deemed that the bonds have been converted into money and capital gains exempted from tax earlier will be reversed.