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October 5, 2020

Selling Commercial Property? Know Income Tax Implication

by CA Shivam Jaiswal in Income Tax

Selling Commercial Property? Know Income Tax Implication

Real estate is generally a great term investment option if you have patience and financial resources to acquire and sustain it. It helps in generating continuous passive income and is a good strategy to begin building wealth for future financial stability and security. Property has been one of the oldest investment avenues in India, which existed before the advent of various financial products like direct equity and mutual funds. People who invest in commercial properties, do so either for their own use or for the purpose of letting it out.

What do you mean by commercial property?

Commercial property refers to real estate property that is used for business activities. Commercial property usually refers to buildings that house businesses, but it can also refer to land that is intended to generate a profit, as well as larger residential rental properties. Commercial property includes malls, grocery stores, office buildings, manufacturing shops, and much more.

From an investment perspective, commercial property has traditionally been seen as a sound investment. The initial investment costs of the building and the costs associated with customization for tenants are much higher than residential real estate, but the overall returns are also higher, and some of the common headaches that come with tenants aren’t present when dealing with a company and clear leases.

How is let out commercial property taxed?

Rentals received from any property owned by you, is generally taxed under the head “Income from House Property” in your hands. This applies to all properties, whether residential or commercial. The higher of the rent that is actually received or the rent that is reasonably expected to be fetched by such a property in the market, is the basis of taxation of rental income.

Taxability as House Property provides a standard deduction which is limited to 30% of the income along with a deduction on interest paid on borrowed capital for the purposes of acquisition, construction, repair, reconstruction, etc. (subject to limitations provided under the Income Tax Act).

In addition to the standard deduction, the tax laws allow for deduction with respect to the interest paid for any money borrowed for the purpose of purchase, construction, repair or reconstruction of your commercial property

In case the property is not owned by you and is sublet by you, the income from such sub-letting of commercial property will be taxed under the head ‘Income from Other Sources’.

What are the tax implications on the sale of commercial property?

Capital gain is the profit one earns on the sale of an asset like stocks, bonds or real estate. It results in capital gain when the selling price of an asset exceeds its purchase price. It is the difference between the selling price (higher) and cost price (lower) of the asset. Capital loss arises when the cost price is higher than the selling price.

With respect to any commercial property owned by you and used for your own business, the profits arising from the sale of such property becomes taxable as short-term capital gains, provided no property is left under the same category of asset, irrespective of the period of your holding.

In case of commercial property which is let out, the profit on sale of such commercial property will become capital gains. The same shall be long-term, if the property is held for more than 24 months and will be taxed at a flat rate of 20%, irrespective of the quantum. However, if the property is sold before 24 months, the same becomes taxable as short-term capital gains and is taxed as normal income.

How to save tax on sale of commercial property?

The sale of capital assets may lead to capital gains and these gains may attract tax under the Income Tax Act. To save tax on these capital gains, a few capital gains exemption/deductions are available under sections 54, 54B, 54D, 54F etc. In the case of short-term capital gain, there’s no option to save capital gains tax on sale of property. The complete capital gain amount will be added to your income and you will be taxed as per the income tax slab you will fall into. Provisions of Section 54, 54EC and 54F of income tax apply only to the long-term capital gains tax on sale of property. Here are 3 ways you can claim exemption from capitals gains tax on sale of commercial property.

Under Section 54F of the Income Tax Act

The income tax law provides for certain situations where such capital gains will not be subject to tax. Section 54F provides one such exemption. In the case of an assessee being an individual or a HUF, if the capital gain arises from the transfer of any long-term capital asset, not being a residential house (original asset) and the assessee has within a period of 1 year before or 2 years after the date on which the transfer took place purchased, or has within a period of 3 years after that date constructed, one residential house in India (new asset), the capital gain shall be dealt with in accordance with the following provisions of this section.

Amount of exemption available under section 54F shall be as follows:

  • When full net consideration is invested: The full amount of long-term capital gain is exempt
  • When proportionate net consideration is invested: Exemption = Long term capital gain * Amount re-invested / Net consideration

Let us refer to the example below to understand this better:

Mr A sold his commercial property in FY 2019-20 for Rs. 15,00,000. It was purchased in FY 2012-13 for Rs. 5,00,000. Mr A purchased his second house property for Rs. 35,00,000 in FY 2019-20. Mr A will be able to claim deduction under section 54F as follows:

Sales Consideration15,00,000
Less: Index Cost of Acquisition (5,00,000*289/200)(7,22,500)
Long Term Capital Gains7,77,500
New House Property Purchase Price35,00,000
Exemption u/s 54F (35,00,000*7,77,500/15,00,000) = 18,14,167 or 7,77,5007,77,500

The assessee cannot transfer the newly purchased or constructed residential house for 3 years from the date of purchase or date of construction, as the case may be. However, in case the assessee transfers the newly purchased/ constructed residential house, then, the capital gain exempted under section 54F would be taxable as long-term capital gain in the previous year in which the residential house is transferred.

Under Section 54EC of the Income Tax Act

Section 54EC of the Income Tax Act, 1961 lays down the provision that capital gains are exempt from tax, if the long-term capital gains are invested in specified investment instruments within a pre-defined time period. Features of Section 54EC are as follows:

  • Exemptions under Section 54EC are only available on gains from transfer of long-term capital assets
  • The person must invest a part or the entire capital gains within 6 months from the date of asset transfer
  • The benefit is available only if the investment is made in the specified long-term assets

The Amount of Exemption under Section 54EC will be least of the following:

  • The Cost of NHAI/REC Bonds (The investment amount cannot be more than Rs. 50 lakhs during the current and succeeding financial year)
  • The Capital Gains on the sale of land or building.

Let us refer to the example below to understand this better:

Mr B sold his commercial property in FY 2019-20 for Rs. 60,00,000. It was purchased in FY 2013-14 for Rs. 30,00,000. Mr B purchased NHAI bonds for Rs. 45,00,000 in FY 2019-20. Jay will be able to claim deduction under section 54EC as follows:

Sales Consideration60,00,000
Less: Index Cost of Acquisition (30,00,000*289/220)(39,40,909)
Long Term Capital Gains20,59,091
NHAI Bond Price45,00,000
Exemption u/s 54EC20,59,091

When bonds are sold within 5 years from the date of purchase, then the exemption u/s 54EC is withdrawn. The amount of exemption availed will be reduced from the cost of the asset. Capital Gains will be the total sales value minus the cost of the asset.

A taxpayer can purchase a house property as well as invest in NHAI/REC Bonds to avail the benefit of exemptions under Section 54F as well as 54EC.

By Investing in Capital Gains Account Scheme (CGAS)

To save tax on capital gains, a few capital gains exemption/deductions are available under sections 54, 54B, 54D, 54F etc. As per the provisions of these sections, the amount is required to be reinvested in specified investment types before the specified period. However, if the due date of filing income tax returns falls before the expiry of the specified period, the amount of capital gains is required to be invested temporarily in the Capital Gains Account Scheme (CGAS) which can be easily withdrawn at the time of investment in the specified instrument.

The time limit available to the depositor for re-investment and availing exemption of capitals gains, in many cases is longer than the due date to file the return of income. In such cases, the taxpayer is given an option of depositing such underutilised capital gains in ‘Capital Gains Account’ introduced under Capital Gains Account Scheme. Any capital gain invested in Capital Gains Account Scheme will be eligible for capital gain exemption as it would in case of re-investment.

By depositing an amount in the Capital Gains Account the taxpayer can claim an exemption from Capitals Gains Tax at the time of filing income tax return. Amount from Capital Gains Account could be utilized subsequently for purchase or construction.

Buying Real estate has always been one of the parameters of success in today’s world. But with lack of understanding and no planning, one could end up in a financial mess. Tax planning is an integrated part of financial planning. Real estate is a costly asset class not only at the time of buying but also while maintaining and selling. Understanding section 54, 54EC and 54F of income tax act is very important so one does not make mistakes of investing the long-term capital gains from the sale of property in the wrong manner and end up paying heavy taxes.

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