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Can You Take A Home Loan And Also Claim Tax Exemption On LTCG?

Profit on the sale of a residential property — held for more than 2 years — is considered as Long Term Capital Gains for the income tax purposes.

You are liable to pay Long Term Capital Gains Tax on the same @20% with indexation benefit.

Indexation benefit allows you to adjust the original cost of property, for the inflation during the period you held the property. Hence, only the real appreciation in the price is taxed.

Thankfully, the Income Tax Act has a provision, whereby you can get exemption on the above tax liability on the long term capital gains.

This is covered under section 54 of the Income Tax Act. As per the same, if you acquire another property  within a specified time-frame  then such capital gains will not be taxed. (If the cost of new property is less than the capital gains, then only the balance excess capital gains will be taxed.)

To claim the aforesaid tax exemption, you have to
(a) Either PURCHASE a ready house property 'one year prior to' or 'within two years after' the sale of old property
(b) Or CONSTRUCT a new house property within three years after the sale of old property

[By the way: You can also save tax on long term capital gains up to a maximum of Rs.50 lakhs, by investing the same in (a) specified 5-years bonds, (b) within a specified period.]

Now comes the crux of this article:

What if you take a home loan to buy this new property as the interest rates are low; while investing the sale proceeds including capital gains elsewhere to earn better returns?

Can you still claim exemption from long term capital gains tax?

The answer is... Yes.

long-term-capital-gains-tax-exemption
Who won the dispute on long term capital gains tax exemption?

Recently, there was a dispute between a Taxpayer and the Income Tax Assessment Officer (AO).

The Taxpayer had claimed tax exemption u/s 54 on the long term capital gains of Rs.59.07 lakhs. He had satisfied the timelines specified in the section to be eligible for such tax exemption.

The AO, however, observed that even though the new property had been purchased within the period stipulated, it had been financed through a Bank Loan of Rs.82.50 lakhs. And, the Capital Gains utilized for purchase of property was only Rs.9.37 lakhs.

As such, the AO asked the Taxpayer to pay tax on the balance capital gains of Rs.49.70 lakhs (= Rs.59.07 lakhs - Rs.9.37 lakhs).

As per the guidelines laid down in the Income Tax Act, the matter was referred to the Income Tax Appellate Tribunal.

The Tribunal noted that
1. Cost of the new property was more than the capital gains
2. Old property was sold in the Financial Year 2009-10 and the new property purchased in the Financial Year 2010-11. Thus, the taxpayer had brought the new property well within the stipulated time frame of 'two' years to purchase a new property.

Money is a fungible commodity. In other words, it is replaceable by another identical item or mutually interchangeable. Hence, identity of funds — namely the Home Loan in this present case — is not the relevant 'argument' to deny tax exemption to the Taxpayer.

In fact, Sec 54 allows tax exemption even if the new property is bought one year PRIOR to the sale of the old property. In such cases, there would be no funds from sale of property and no capital gains, when the new property is bought. Naturally, therefore, in these instances some other funds would be utilized to acquire the new property. Yet, this transaction is considered valid for tax exemption u/s 54.

Hence, to ask the Taxpayer to pay long term capital gains tax, merely because he availed of a home loan, is not correct. He continues to remain eligible for tax exemption u/s 54 so long as the timelines stipulated are being adhered to.

Therefore, the Tribunal passed a ruling that the Taxpayer had met the conditions specified u/s 54 and was eligible to claim tax exemption on the entire gains of Rs.59.07 lakhs.

In a nutshell... yes you can take a Home Loan and also claim tax exemption on the Long Term Capital Gains from sale of house property.

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