Housing has come a full circle

The Budget has some proposals that would impact home buyers and sellers

The property sector did not figure prominently in the recently presented Budget. Still, there are two changes, mainly tax related, that could impact home buyers and sellers.

Circle rate

One big change concerns how taxes are calculated when the guideline value or circle rate differs from the actual sale price. Property in every locality is given a rate by the State government to provide guidelines on the transaction value. This ready reckoner rate prevents gross under-reporting of property value to save on income tax and stamp duty.

The circle rates are revised from time to time based on market conditions. In the past, when property markets were on an uptrend, circle rates lagged transaction prices. Even if they matched the market, actual sales prices would vary from the guideline values based on the location of the plot — on the main road versus something a little inside — or its shape — square versus uneven shapes. In the case of homes, the variation from the circle rate may be even more, based on how the interiors are done, structural strength or the floorplan.

Tax method

When there is a property transaction, the higher of the transaction price and circle rate is used for tax purposes. Often, market rates are higher, and deals are recorded at guideline value, with cash paid for the rest. But with property prices falling, transactions in the secondary market are below the guideline value in many markets.

This leaves sellers in a sticky situation as they pay taxes on gains based on the guideline value. And if investors are made to save on long-term capital gains, that is also based on the circle rate. The buyers are hit by this as well — the difference between the circle price and actual price is taxed as a gift (if it exceeds ₹50,000).

The change

The Budget has made a small change to the existing method, in some circumstances. If the property price is lower than the guideline value by less than 5 per cent, no adjustment needs to be made and the tax can be computed on the actual sale consideration. For instance, if a property purchased for ₹25 lakh has a current circle rate of ₹30 lakh and is sold for ₹29 lakh. In the old method, capital gains tax for the seller would be on ₹5 lakh (₹30 lakh-₹25 lakh). Now, it would be on ₹4 lakh (₹29 lakh-₹25 lakh). For a buyer, the difference between circle rate (₹30 lakh) and the consideration (₹29 lakh) was treated as a gift in the past. This is not the case now.

The change is a rationalisation provision that brings in more clarity to a rule which was already in place, says Venkat Krishnamurthy of V Ramaratnam & Company, a chartered accountant firm.

He notes that this will push the States to ensure that circle rates are reflective of the current market prices. Shrinivas Rao, CEO – APAC, Vestian, a real estate advisory firm, says that the change will only benefit a small number of property markets where the difference in rates is marginal.

Change in holding period

The other proposal in the Budget relates to the holding requirement of bond investments made by sellers to save on long-term capital gains tax. Long-term gains tax may be saved if the profit is reinvested in another property.

Alternatively, profit of up to ₹50 lakh per year can be invested in capital gains (54EC) bonds for a period of three years. These bonds are issued by NHAI and REC and the interest rate is 5.25 per cent currently. The Budget has increased the minimum holding period to five years. For 2018-19, these bonds will be issued with five-year tenure and the new interest rate will be announced.

The change dents the gains to a seller — a longer holding period will lower returns, as the tax saving is spread over five years. For example, if the gain was ₹1 lakh, it could be invested in the bonds, saving ₹20,000 in tax and earning an interest of ₹26,250 (at 5.25 per cent per year) over five years. The investor is left with ₹1,26,250 after five years (ignoring tax on interest).

Given the low returns from property investments, typically longer holding periods and illiquidity, it is still prudent to consider bond investment. Those who may need the money before five years, can pay taxes and invest in instruments that suit their risk profile. Even those who can wait for five years, can also analyse the likely return on their after-tax investment against bonds, as well as their tax bracket and pick accordingly.

The writer is co-founder, RaNa Investment Advisors

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