Maximize Tax Savings on Selling Commercial Property | CA Pritish Burton

Table of Contents

1. Introduction
2. Understanding Capital Assets
3. Taxation of Commercial Property Sale
   • 3.1. Tax on Residential House Property
   • 3.2. Tax on Commercial Property
4. Long-term Capital Gain vs Short-term Capital Gain
5. How to Save Capital Gains Tax on Sale of Commercial Property
   • 5.1. Section 54F
   • 5.2. Section 54EC
   • 5.3. Capital Gain Account Scheme
6. Example of Tax Calculation on Sale of Commercial Property
7. Exclusions and Limitations
8. Frequently Asked Questions (FAQs)
9. Conclusion

Understanding the Tax Implications of Selling Commercial Property

Selling a commercial property or plot can be a complex process, especially when it comes to understanding the tax implications involved. As a property owner, it is crucial to be aware of whether you will be subject to capital gain tax when selling a commercial property. In this article, we will provide you with all the necessary information to clarify any doubts you may have regarding the sale of a commercial property.

1. Introduction

The sale of a commercial property falls under the category of capital assets, alongside residential properties, plots, and various financial assets such as shares and bonds. Any gains made from the sale of these assets are subject to taxation under the head of capital gains. However, it's important to note that the sale of rural agricultural property is exempt from capital gains taxation, whereas non-rural agricultural property falls under the same tax regulations as other capital assets.

2. Understanding Capital Assets

A capital asset is defined as any asset that results in a gain upon sale. This includes commercial properties, residential properties, plots, shares, and bonds. When you sell a capital asset, the profit made from the sale is categorized as capital gains.

3. Taxation of Commercial Property Sale

When it comes to the sale of a commercial property, the tax implications differ from those of a residential property. Income generated from renting out a commercial property is taxed separately under the "Income from House Property" category. However, when you sell a commercial property, any gains made are considered capital gains and are subject to specific tax regulations.

3.1. Tax on Residential House Property

Before delving into the tax implications of selling a commercial property, it is essential to understand how capital gains are taxed on the sale of a residential house property. A separate video has been dedicated to providing a detailed explanation of how to save capital gains tax in this scenario.

3.2. Tax on Commercial Property

When you sell a commercial property, including office buildings or shops that are let out, the gain made from the sale is subject to capital gains tax. The taxation method involves differentiating between long-term and short-term capital gains.

4. Long-term Capital Gain vs Short-term Capital Gain

The classification of capital gains as long-term or short-term depends on the duration between the purchase and sale of the asset. If a property is held for a period exceeding or equal to 24 months, it is considered a long-term capital asset, and the sale of such an asset results in long-term capital gains. On the other hand, if the property is sold within 24 months of purchase, it is classified as a short-term capital asset, and the gains are deemed short-term capital gains.

It's important to note that long-term capital gains are taxed at a fixed rate of 20%, while short-term capital gains are added to the individual's regular income and taxed according to their applicable slab rates, which range from 10% to 30%.

5. How to Save Capital Gains Tax on Sale of Commercial Property

Now that we have a clear understanding of the tax implications for selling a commercial property, let's explore three different options available to save on capital gains tax in this scenario.

5.1. Section 54F

Under Section 54F, if you invest the entire sale proceeds from the commercial property into a new residential house, you can enjoy a complete exemption from capital gains tax. It's important to note that the entirety of the sale proceeds, rather than just the capital gains, must be invested. Additionally, the investment in the residential house property must be made within specific time limits. You have the option to invest one year prior to the sale, two years after the sale, or three years if you plan to construct a new house property.

Pros:

• A complete exemption from capital gains tax can be achieved by investing the entire sale proceeds in a new residential house.

Cons:

• Section 54F exemption is not applicable if you own more than one residential house property at the time of the commercial property's sale.
• This exemption is also not valid if you purchase another residential house property within a year from the date of the commercial property's sale or if you construct a new residential house property within three years.

5.2. Section 54EC

Under Section 54EC, you have the option to invest the entire long-term capital gains, and not just the sale proceeds, into specified bonds such as National Highways Authority (NHA) bonds or Rural Electrification Corporation (REC) bonds. This investment must be made within six months of the sale of the commercial property. It's important to note that the investment must be done before filing your income tax returns. Furthermore, if you choose this option, you will need to remain invested in the bonds for a minimum of five years. If you withdraw before the completion of the five-year period, the exemption granted will be withdrawn, and you will be liable to pay the applicable capital gains tax.

Pros:

• Investing in specified bonds provides a way to defer capital gains tax by utilizing the funds for a specific purpose.
• If you invest both in a residential house property and Section 54EC bonds, you can avail of exemptions for the remaining balance of long-term capital gains, effectively reducing your overall tax liability.

Cons:

• Requires a minimum investment period of five years in specified bonds.
• Withdrawing before the completion of the five-year period results in the withdrawal of the exemption and incurs tax liabilities.

5.3. Capital Gain Account Scheme

If you do not plan to reinvest the funds into a residential house property or specified bonds, an alternative option is to deposit the amount in a designated bank account called a "Capital Gain Account Scheme." This scheme allows you to utilize the funds from the account for either the purchase or construction of a house property. However, it's crucial to remember that the funds must be utilized before filing your income tax returns for the year. Failure to do so will result in the withdrawal of the capital gain exemption.

6. Example of Tax Calculation on Sale of Commercial Property

To provide a better understanding of how taxes are calculated on the sale of a commercial property, let's consider an example:

Suppose you purchased a commercial property or plot for INR 10 lakhs in the financial year 2010-11, and you sold it for INR 25 lakhs in the financial year 2021-22. Considering the cost inflation index, the indexed cost of acquisition is around INR 19 lakhs. Thus, the capital gain in this case is INR 6 lakhs (25 lakhs - 19 lakhs).

If you decide to invest only a part of the sale proceeds, let's say INR 15 lakhs, instead of the entire sale proceeds of INR 25 lakhs, you can calculate the exemption using the following formula:

Exemption = Cost of the new house * Capital gains / Sale proceeds

For example, using the given figures, the exemption would be:

Exemption = INR 15 lakhs * INR 6 lakhs / INR 25 lakhs = INR 3.6 lakhs

Therefore, the taxable capital gain in this case would be:

Taxable Capital Gain = INR 6 lakhs - INR 3.6 lakhs = INR 2.4 lakhs

The taxable amount of INR 2.4 lakhs is subject to a tax rate of 20%.

7. Exclusions and Limitations

It's crucial to be aware of certain exclusions and limitations when it comes to saving on capital gains tax on the sale of a commercial property:

• The exemption under Section 54 is not available if you own more than one residential house property at the time of selling the commercial property.
• The exemption under Section 54 is also not available if you purchase another residential house property within one year from the date of selling the commercial property or construct a new residential house property within three years.
• Section 54EC bonds require a five-year lock-in period. Premature withdrawals result in withdrawal of the exemption.
• Failure to utilize the funds deposited in the Capital Gain Account Scheme before filing your income tax returns for the year will lead to the withdrawal of the capital gain exemption.

8. Frequently Asked Questions (FAQs)

Q1. Can I invest in both a residential house property and Section 54EC bonds to save on capital gains tax?

Yes, you can invest in both a residential house property and Section 54EC bonds. If you have remaining long-term capital gains after investing in the residential property, those gains can be invested in the bonds to avail further exemptions.

Q2. What happens if I withdraw from Section 54EC bonds before the minimum five-year lock-in period?

If you withdraw from Section 54EC bonds before the completion of the lock-in period, the exemption initially granted will be withdrawn, and you will be liable to pay the applicable capital gains tax.

Q3. What if I am unable to purchase or construct a house property before filing my income tax returns?

If you are unable to invest in a residential house property before filing your income tax returns, you can deposit the amount in a Capital Gain Account Scheme. This gives you the flexibility to utilize the funds for the purchase or construction of a house property at a later date.

For more questions and doubts, please feel free to comment below, and we will provide answers and clarifications.

9. Conclusion

Understanding the tax implications of selling a commercial property is crucial for property owners. By comprehending the difference between long-term and short-term capital gains and familiarizing yourself with the various options available to save on capital gains tax, you can make informed decisions and optimize your tax liabilities. It's essential to consult with a tax professional or financial advisor to ensure compliance with the relevant laws and regulations.

Thank you for reading this article, and we hope it has provided valuable insights into the taxation aspects of selling commercial property. Stay tuned for more informative videos and articles on taxation, personal finance, and investment. Happy investing!

Resources:

• Video on Saving Capital Gain Tax on Sale of Residential House Property