One excellent approach to generate passive income is rental property ownership. What then happens when you choose to sell it? Though you will have to pay tax on it, you could make a good profit. Capital gains on rental property are what they are called. Let’s dissect it such that it’s clear-cut and demonstrates how to legally lower your taxes.
Capital gains on rental property:
Capital gain is what results when you sell a rental property for more than what you paid for it. Under Indian income tax codes, it is taxable. The tax hinges on your length of property ownership:
- Short-term capital gain, or STCG: Should sales occur two years following purchase.
- Long-Term Capital Gain (LTCG): Should sold following two years.
Capital Gain Tax Rates on Rental Property:
- Short-Term Capital Gain (STCG): Added to your overall income, taxed according to your slab of income taxes.
- Long-Term Capital Gain (LTCG): Taxed at a flat twenty percent.
Using indexation benefit—that is, inflation-adjusting the purchase price—allows one to…
Capital Gain Calculation Methodology:
Here’s a basic LTCG formula:
LTCG = Sale Price less Indexed Purchase Price plus Improvement Costs plus Selling Expenses
Adjusted for inflation with Cost Inflation Index (CII), the purchase price index.
Major repairs, renovations (with expenses) call for improvement costs.
Selling costs include legal fees, brokerage, etc.
An illustration:
- Paid ₹30 lakh for bought land in 2010.
- Marketed in 2024 for ₹80 lakh.
- Indexed cost = ₹30 lakh times CII 2024 ÷ CII 2010.
- Assumed indexed cost = ₹60 lakh.
- LTCG = ₹80 lakh less ₹60 lakh = ₹20 lakh.
- Tax = twenty percent of ₹20 lakh = ₹4 lakh.
How can one save capital gains taxes on rental property?
- Section 54: Purchase another house for yourself. Must construct in three years or buy within two years. New homes have to be in India. Exemption equals the cost of the new property (up to the capital gain level).
- Section 54EC: Invest in Bonds for Capital Gains. Invest within six months up to ₹50 lakh in NHAI/REC bonds. Five years is the lock-in period. In such a case, gains become tax-free.
What Should You Not Reinvest in?
You then report the relevant capital gains tax you paid in your ITR (usually ITR-2 or ITR-3).
Files to Save:
- Original purchase and sale deeds.
- Expenses related to receipts of improvement.
- Evidence of bonds bought or reinvestment.
- TDS certificates (should the buyer pay you taxes deducted from their purchase).
Last Consideration:
Although selling a rental property can be profitable, pay attention to the tax component. Knowing capital gains on rental property helps you avoid last-minute surprises, save tax legally, and better plan. If you’re not sure, always see a tax professional to get it correct—especially in cases of significant gain.