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Capital Gains Bonds: Should you invest in 54EC bonds or are there better alternatives?

You can save tax on long-term capital gains arising from transfer of property by reinvesting the gains in Capital Gains Bonds, as also by reinvesting in another residential property. What makes sense?

Hemisphere Properties India: Hemisphere Properties invites Expression of Interest for farm house plots. The company invited Expression of Interest for farm house plots on land parcel in Chattarpur, New Delhi.

Hemisphere Properties India: Hemisphere Properties invites Expression of Interest for farm house plots. The company invited Expression of Interest for farm house plots on land parcel in Chattarpur, New Delhi.

There is an old proverb that goes 'A penny saved is a penny earned’. This means that it is as good to save money that you already have as it is to earn more. Likewise, it is wise to save your gains from taxation.

There are various legitimate ways of reducing your tax outgo. One such is to invest in capital gains tax exemption bonds to save tax on long-term capital gains (LTCG). Recently, REC (formerly Rural Electrification Corporation) launched the REC Capital Gains Tax Exemption Bonds-Series-XVI for people to invest and save tax on capital gains. Read more about it here.

However, tax on LTCG from property transfer can also be saved by reinvesting in residential property within the stipulated time. But the question is, whether it make sense to reinvest the capital gains in 54EC bonds, or buy a residential property to save tax, or pay taxes and invest the remaining in other better options. Let’s explore:

The tax

A gain from sale of a residential property (land, house or apartment) within two years of its purchase is considered short-term capital gains (STCG); after two years, the gain is considered long-term capital gain (LTCG). While STCG is taxed at the slab rate, LTCG is taxed at the rate of 20.6 percent (including cess) with indexation. So, if you make an LTCG of Rs 50 lakh by selling your old house, your tax liability would be Rs 10.3 lakh. However, if you want to save this Rs 10.3 lakh, you should reinvest the entire capital gains, i.e. Rs 50 lakh in tax-savings bonds or in a residential property.


Also read: Should you rent a property or buy one?

The bond

You can invest as little as Rs 20,000 in capital gains bonds; the maximum investment limit in a financial year is Rs 50 lakh. However, in case of jointly-held assets like real estate, each owner has a separate limit of up to Rs 50 lakh for investing in these bonds.

These bonds are backed by the government and carries the highest ratings from rating agencies, and are therefore considered as safest investments. But the problem is the long five-year lock-in period and a meagre interest of 5 percent per annum, that too taxable in the hands of the investor.

Reinvesting in property

The other option to save tax on LTCG is reinvesting the gains in residential property (maximum two) within a period of one year before or two years after the date of transfer of old house or construct a residential house within a period of three years from the date of transfer of the old house. Remember, the exemption for investment made by way of purchase or construction in two residential house properties shall be available if the amount of LTCG does not exceed Rs 2 crore. Also, remember that once you exercise this option, you will not be entitled to avail of it again in future.

However, reinvesting in a residential property is a task in itself, and that too with considerable transaction cost. From identifying a right property, to doing due diligence and negotiation, completing the legal formalities and possession process takes a lot of effort. Stamp duty, registration charges and assistance fee of legal experts and real estate agents will add up to close to 10 percent of the property value. If you buy an under-construction property, you also have to pay GST. In such a scenario, you may think that you are paying more in the form of taxes and charges than what you are saving by way of reinvestments.

Other options

Given the low returns, lock-in in 54EC bonds, high transaction cost, and effort and risk involved in reinvesting in real estate, many financial planners are of the view that paying tax and reinvesting the fund in an appropriate manner can be a better option.

It may be a much better idea to pay taxes and invest the rest in an appropriate vehicle and earn better returns. There certainly is a potential to even recoup the money paid as taxes, if the asset one invests in does well in those five years. By investing in capital gain bonds, one's money is also locked up for five years. By not doing this investment, it gives the flexibility to use it for any requirement that one may have,” said Suresh Sadagopan, Founder and Principal Officer of Ladder7 Wealth Planners.

One can look at equity-based products with a long-term view for investments. “Direct equity, mutual funds, PMS, etc are areas in which one can invest and have the potential to earn double-digit annual returns if the investment is kept for a long period (five years or more),” added Sadagopan.

Moreover, besides returns, one should also look at the need for liquidity. “The decision to reinvest the gains should be in line with your financial needs and goals. Tax savings should be incidental and not the primary factor to decide which product to invest in,” said Rishad Manekia, founder and MD, Kairos Capital, a SEBI-registered investment advisor.

The purpose of the fund should drive the decision. “If you need the money in a short span of time, it is better to look at other avenues which offer better risk-adjusted returns and flexibility,” added Manekia.

So, if you want to avoid market risk and your short-term goals are not alligned with the fund received from the transfer of property, you may prefer to choose to invest in 54EC bonds. However, if you have a longer investment horizon and are willing to take additional risk, or you may need the fund for near-term goals, you may opt to pay the tax on your capital gains and evaluate other investment options for deploying the funds.
Ashwini Kumar Sharma
first published: Jun 13, 2022 10:10 am
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