In this article, we’re going to explore these capital gain bonds, understand how they function, gauge how much interest you could receive by investing in these bonds, and talk about everything else you need to know too.
What are capital gain bonds?
Capital gain bonds are specifically designed to help you save money on long-term capital gains taxes. Suppose you sell a property that you held for more than 2 years. Normally, you would have to pay tax on the profits of this sale. However, if you invest in capital gain bonds, you could find an escape route.
Here’s how they work.
- You invest the capital gains you earned from selling the property (land, building etc.) in these special bonds.
- By investing within 6 months of the sale, the entire amount you invest becomes exempt from capital gains tax.
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Key characteristics of capital gain bonds
Here are some key things you need to note before investing in these bonds:
- They are issued by specific government-backed institutions like PFC, NHAI, IRFC and REC.
- These bonds come with a lock-in period of 5 years. This means that your money is stuck until maturity.
- The interest rates offered by these bonds are fixed by the government and may depend on the institution that’s issuing them. Since these institutions are mostly government-backed and the bonds are rated AAA, the rate of interest is not very high.
- These bonds are not listed on any stock exchange.
- The interest income on such bonds is taxable, and must be filed under ‘Income from Other Sources’ at the slab rate applicable to the taxpayer for the financial year.
- You cannot redeem these bonds or take loans against them in any financial institution in India.
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Which asset can be a capital asset under this exemption?
Here are the specifications of how the Income Tax Department classifies long-term capital assets:
- Land: This includes any vacant land or plot you own.
- Building: This refers to any residential or commercial building you hold ownership of. It can be a single unit or an entire building.
- House Property: This encompasses your entire residential property, including the land and the building constructed on it.
Additionally, the asset must be held for more than 24 months to qualify as a long-term asset. Inherited property can also be a capital asset if held for more than 24 hours post-inheritance.
What is Section 54EC?
Section 54EC specifies that the capital gains arising from the transfer of long-term capital assets can be exempt from these taxes if the following conditions are fulfilled:
- The asset should be a long-term capital asset, which could either be land, a building, or both.
CTA: Real estate industry in India - These capital gains should be invested in these bonds within 6 months from the date of transfer of the asset.
- The bonds under which these exemptions are allowed are issued by Rural Electrification Corporation(REC), National Highway Authority of India(NHAI), Power Finance Corporation Limited(PFC) or Indian Railway Finance Corporation Limited(IRFC).
- The maximum limit for claiming these exemptions is ₹50 lakh per financial year, no more.
Frequently Asked Questions
Can I invest in Capital Gain Bonds if my capital gains arise from selling stocks or mutual funds?
No, Capital Gain Bonds are only applicable for long-term capital gains arising from the sale of capital assets like land, building, or residential property held for more than 24 months. Gains from selling stocks, mutual funds, or other financial assets are not eligible for this tax exemption through Section 54EC bonds.
What happens if I don’t invest the entire capital gains amount in Section 54EC bonds?
If the capital gains amount you earned is higher than the amount you invest in Section 54EC bonds, only the portion invested will be exempt from capital gains tax. The remaining capital gains will be taxed as per the applicable long-term capital gains tax rate.
Can I invest in multiple tranches (parts) throughout the 6-month window?
Yes, you can invest in Capital Gain Bonds in multiple tranches within the 6-month window from the date of sale of the capital asset. However, ensure you have proper documentation for each investment to claim the complete tax benefit.
What happens if I redeem the Capital Gain Bonds before the 5-year lock-in period?
Premature redemption of Capital Gain Bonds before the 5-year lock-in period is not allowed. If you redeem them prematurely, the entire invested amount will lose its tax-exempt status and will be added to your taxable income for that year. Additionally, you might face penalties depending on the specific bond issuer’s terms.
What are the alternatives to Capital Gain Bonds for saving capital gains tax?
If the 5-year lock-in period of Capital Gain Bonds doesn’t suit your investment needs, you can explore other options under Section 54 of the Income Tax Act.
- Investing in a new residential property within a specific timeframe.
- Investing in specific government schemes like Senior Citizen Savings Scheme (SCSS) or Rajiv Gandhi Equity Savings Scheme (RGESS).
These instruments could also help you save some long-term capital gains taxes that accrue against your asset sale.
