Mutual Fund SIPs and their Capital Gains Taxation

Systematic Investment Plans Or SIPs is a very convenient and most commonly used method for most investors to enter the equity market via Mutual Funds. By understanding the tax implications of SIP transactions, you can time your withdrawals accurately and save on taxes.

Is switching of funds taxable (QandA : 010)

Question : 010
Is switching of funds taxable?
Let us say you want to switch from one mutual fund to another (of the same or another company) fund in less than 12 months. Will the switching attract short term capital gains tax?

What is the Cost Inflation Index for FY 2014-15 AY 2015-16 (QandA : 003)

Question 003

What is the Cost Inflation Index for FY 2014-15 AY 2015-16? 

10 most common Mutual Fund Myths

Mutual Funds are just the right solution for investors ready to take reasonable risk and do not have time to analyse and dissect organisation data. Each one of us will probably touch Mutual Funds at some point of our financial investment cycle. Here are the 10 most common myths surrounding Mutual Funds that you must be aware of .. read on...

Save Taxes on Capital Gains

Capital Gains are different from money gains. These are the biggest gains that you would ever earn in your life. Understand how to get smarter with capital gains and saving taxes arising out of such gains.. Read More.

Double Indexation Benefit on Debt Funds

Background

Many investors park their surplus fund in fixed maturity plans (FMPs) and other debt funds in March every year to take advantage of the double indexation benefit and to bring down (and almost eliminate) the tax liability on returns.

Tax Exemption Provision for Capital Gains through Property

 

Real Estate Capital gains is one of the biggest single transaction gains that you would ever have in your portfolio. If the Capital Gain is high, the tax liability would obviously be one of the highest. In one of our recent posts, we studied in detail about the tax liability on capital gains on account of real estate or property. ( Preserve your Property Gains ). 

Hence, it becomes all the more important to understand what you can do with the capital gains that we have so as to minimize or completely eliminate any such tax liability. A small understanding of facts here can save us lacs of rupees in terms of tax savings in a single transaction.

Here are some facts that you should be aware of :

1) All tax exemption provisions for capital gains through sale of property (as listed in the subsequent points) are applicable only if you have incurred Long Term Capital Gains. There is no tax exemption possible for Short Term Capital Gains. (Refer Preserve your Property Gains ).

2) Re-invest in buying new property : If you invest part  / full amount of your capital gains in a new residential house property, then you are 100% exempted from taxes on Capital Gains. Remember that this re-investment needs to be done between the time period of either a year before or two years after the sale of the original residential property.

3)Re-invest in construction of a new property : The same benefit as given in pt 2 above is also available if you invest your capital gains (either partial or full) for the construction of a new residential property. Remember that the new property construction has to be done within 3 years of the sale of the original house property.

4) Partial Capital Gains Re-investment : If you invest, lets say, 70% of our capital gains, you get tax exemption on the 70% part of your capital gains. You will have to pay long term capital gains on the remaining 30% gains.

5) The newly acquired residential property (as in pt 2 above) has to be held for at least 3 years. If you sell the new property in less than 3 years, then you will have to pay tax on the entire capital gain that was tax exempted earlier and also the applicable capital gains on the newly acquired property.

6) You can also save taxes on capital gains by investing in specific bonds issued by National Highway Authority of India (NHAI) and Rural Electrification Corporation. This investment needs to be done within a maximum of 6 months of the transfer of the original house property. Also, these investments in bonds cannot exceed a maximum limit of Rs. 50 Lacs. Just like re-investment in property, the investment in bonds has to be held for a minimum period of 3 years.

7) While you are doing these re-investments, some of which may take time to materialize (may be even years), where do you hold your capital gains in that interim time period which tells the government that you intend to reinvest these capital gains within the time frame given in all the above options, and are hence not liable for taxes? The right procedure for that is to open a separate CGAS account (Capital Gains Account Scheme). You need to put all your capital gains during a financial year into this CGAS account (which can be opened with any bank) before the end of the financial year in which you did the sale of your property. The amount deposited is deemed to be earmarked for purchase or construction of a new residential property, and is hence not taxable during that year.

In nutshell, never sell a property for capital gains in less than 3 years. 

Once you have crossed the 3 year threshold, there are so many options available to re-invest your capital gains to avoid taxes.

Cheers

Manoj Arora

Related Post Topics:

Home

Tax Rebate

Income Tax

Financial Freedom

Preserve your Property Gains

 

Real Estate, as an investment tool, normally rewards you with enough annual returns, sometimes in line with what stocks can provide you. Though Stocks / Equity still remain the best choice considering relatively smaller investment, liquidity and extremely high return potential, Real Estate (in developing countries) remains the 2nd best option.

Though the upcoming book (From the Rat Race to Financial Freedom) would guide you on how to truly invest in real estate, there are a few tips you should keep in mind when you are selling your real estate investment to book profits or to subsequently invest your profits somewhere else. Knowledge of certain rules and laws would only help you to preserve your gains that you realize through this investment tool.

Short Term Capital Gains

If you sell your property within 3 years (36 months) of the date of acquisition, your property would qualify as a Sort Term Capital Asset (STCA) and the gains that you realize out of this sale would qualify as Short Term Capital Gains (STCG)

Here are the salient taxation laws for Short Term Capital Gains

1. Any STCG is considered as your taxable income for that year and should be included as your income when you file your income tax returns.

2. Since the profits are qualified as income, they are taxed as per the income tax slab applicable for you for that financial year.

3. This is the least efficient means of getting returns from real estate as an investment. One should consider this option only in case of emergency need of funds.

Long Term Capital Gains

If the holding period for your property exceeds 36 months,such property qualifies as a Long Term Capital Asset (LTCA) and the gains realized from its sale as Long Term Capital Gains (LTCG)

Here are the salient taxation laws for Long Term Capital Gains

1. LTCG is taxed at a flat rate of 20% after indexation of cost

2. Indexation of cost is very important and has a significant positive impact on you wrt the tax liability. 

3. Indexation of Cost typically means that for calculation of your gains, the cost of the house is uplifted by the inflation index for each year till the sale is made. So, your net indexed gain is less than the actual gain, resulting in reduced tax liability.

It makes lot of sense to wait for more than 3 years if you are selling your property for investment gains. Let us understand in some more detail through a simplified example.

Example:

Let us assume that you bought a house with the following details

Cost of Purchase : Rs. 20 Lacs

Expenses on improvement : Rs. 5 Lacs

Total Cost : Rs. 25 Lacs

Selling Price : Rs. 40 Lacs

Case 1 : House is sold within 3 years

Applicable Gain : STCG

STCG : Rs. 40 Lacs - Rs. 25 Lacs = Rs. 15Lacs

Taxable Income : Rs. 15 Lacs

If you are in the highest tax bracket (30%), your total tax : Rs. 5 Lacs.

Case 2 : House is old just after 3 years

Applicable Gain : LTCG

Indexation adjusted cost of purchase :  Rs. 33 Lacs (assuming approx 10% inflation every year for 3 years)

LTCG : Rs. 40 Lacs - Rs. 33 Lacs = Rs. 7 Lacs

Taxable Income : Rs. 7 Lacs

Your total tax (flat 20%) : Rs. 1.4 Lacs.

Summary : 

1) You saved Rs. 3.5 Lacs on taxes just by waiting for 3 years to pass by.

2) Education cess is applicable in both cases of LTCG and STCG, though not considered in the above example, just for the sake of simplicity.

3) Note that money spent on house improvement is also included in your cost, and helps you reduce your tax liability.

4) There are laws that help you save or re-invest the LTCG, thus avoiding any tax at all. That topic would in the scope of the next post.

Cheers

Manoj Arora

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