During the last couple of years, “Real Estate” has become the buzz-word for everyone.Innovative schemes such as “Construction Linked Instalment based payment plan” and “Pay 15% now and balance on possession of flat” have brought cheers to both investors and actual home buyers.

While such schemes have enabled people from the middle and lower middle class to realize the dream of owning their own home, investors have laughed their way to the bank through prudent trading in real estate. However, not many are aware as to how to treat these transactions from an Income Tax perspective.

Let us understand the tax treatment when the sale of such property happens while it is still under construction.   

Let us assume that Mr Bharat and Mr Nitin book a flat in a yet-to-be-constructed project by paying an amount of Rs 2 Lacs each on 1st July 2007 against which they are each issued a letter of allotment by the builder.The rest of their payments are construction linked till possession. They further pay Rs 5Lacs, 4Lacs and Rs 6 Lacs respectively on 30th December 2007, 10th August 2008 and 30th September 2009. The possession of the property is given on 1st September 2010.

Mr Bharat sells the property on 31st August 2010 for Rs 25 Lacs before taking the possession while Mr Nitin sells his flat on 15th October 2010 after taking the possession of the flat.

 1)Firstly, we need to determine what type of asset are we dealing with?

For this purpose, it is important to note that there is a difference between a flat which is still under construction and for which the possession has not been given to you by the builder, and a flat which is ready and the possession has already been taken by you.Though both are capital assets, in the first case the asset is not the flat (as it is not yet complete and, therefore, not in existence) but the right to acquire a flat, while in the second case the asset is the flat itself.

 2)Next we need to determine whether we are liable to Long Term or Short Term Capital Gains Tax.

As per the Income Tax Act 1961, any capital asset which is held by an assessee for more than 36 months (12 months in case of certain specified assets) will be treated as a Long Term Asset.

It is important to understand that where a flat is booked with a builder under a letter of allotment or an agreement to sale, this represents only a right to acquire the flat and if such a right is acquired more than 36 months back, it becomes a LONG TERM ASSET entitled to a concessional Tax rate of 20% and indexation benefits as well.However, once the possession of the flat is taken, the small right to acquire the flat merges into a larger right of actual ownership of flat and the earlier asset (i.e. right to acquire the flat) loses its identity.

Thus once the possession of the flat is taken the asset becomes “The FLAT” itself and the period of holding for determining the 36 month period would again commence from the date of possession.

Hence, if the flat is sold just after possession, the transaction would be liable to short term capital gain taxable at slab rates (which can even be as much as 30%). Moreover, the seller would also lose the benefit of indexation which is available in case of sale of long term asset.       

We can see the TAX computation of the above example for greater clarity.

In the above case of Mr Bharat, what he has sole is the “right to acquire the flat” which he has been holding for more than 36 months .Therefore he would be entitled to Long Term capital Gains and  his tax liability shall be calculated as follows:

Additionally Mr Bharat would also be entitled to benefits under section 54

However, In the case of Mr Nitin, the asset has been sold after possession and therefore it is the “Flat” which has been sold. Since the period of holding the” Flat” is less than 36 months, Short Term Capital Gain shall be applicable.

In such a case his tax liability will be calculated as below:

Moreover Mr Nitin would not be entitled to benefits under section 54

If you are, therefore, intending to sell the flat soon after taking possession, it is better to carry out the sale while the flat is still under construction and possession is not yet taken by you. This will substantially reduce your tax liability in respect of the capital gains, provided of course that three years have elapsed since you entered into the agreement for purchase of the flat.

Please Note:

1)The tax treatment will be different for a person who is dealing in property as a business and not as an investor.

As per the Law, the sale proceeds of the flat can be treated as business income or capital gain depending on the manner in which the asset is held.

The same asset can be stock-in-trade in the hands of a person who deals in it; whereas it will be treated as a capital asset in case of another person who holds it as investment.

For example, in the above case if Mr Bharat or Mt Nitin were to be a property dealer, the income on the sale of such asset would be treated as business income in the year in which the flat is sold and the income would be taxed at normal slab rates.

2)Method for Calculating Indexed Cost of Acquisition

Formula for computing indexed cost:

Indexed Cost = (Cost Inflation Index for the year of sale/Cost Inflation Index in the year of acquisition) x cost.

For example, if a property purchased in Financial Year 1991-92 for Rs 20 lakh were to be sold  in Financial Year 2008 -09 for Rs 80 lakh, indexed cost = (582/199) x 20 = Rs 58.49 lakh.

The Cost Inflation Index (CII) is notified by the Central Government every year and is publicly available.