Selling your own home can be like removing your own appendix.
It can be painful from an emotional perspective as well from taxation.
Why should I pay tax when I am selling off my house that I had built with so much of care? I mean, I either burn my hard earned income or take a life- time loan to get a property and then, at some point in time, I want to get rid of it. Again I spend money as commission to get a potential buyer. Finally, after getting the sale proceeds, an uninvited guest come in the disguise of Capital Gain Tax (CGT). Does it make any sense?
In this world nothing is certain but death and taxes
What is Capital Gain?
An increase in the value of the asset (in this case, property) that gives it a higher worth than the purchase price. This gain is not realized until it is sold.
You would have bought a property for 10 million and sold it for 20 million (due to the increase in the market value of the property), the gain which you make here is termed as “Capital Gain”. This is not only on the house but also attracts when you try to sell bonds, shares etc.
To understand the reasoning of this tax structure, we should dig into history to get a clear picture. Straightforward reason is people then, were transferring their income to capital/any assets in order to avoid income tax. So Capital Gain Tax was levied to curb the explicit gain made by selling the property.
Capital gain tax is applicable on most of the capital assets (which we do not consider as capital in layman’s understanding). The list varies based on your tax jurisdiction. For this article, let’s keep aside the tax structure.
Capital gain could be long term or short term capital gain. This is determined by the holding time of the investment before being sold. If the investment is held for one year or less, then the gain realised by selling that asset comes under the purview of short term capital gain. If the asset is held for more than one year, then gain is termed as long term capital gain.
This differentiation is important because, the tax rate would be different for Long Term Capital Gain(LTCG) and Short Term Capital Gain(STCG). Generally, LTCG is taxed at lower rate than STCG.
Why lower tax rate on LTCG?
Primary intention to impose lower rate is to stimulate the economy for investing more in the capital assets and put to use for greater time. If the tax is set too high, it can discourage even the most glaringly urgent transfers of control.
Tax Rates
You can check the prevalent capital gain tax rate in your country in the below link
http://www.globalpropertyguide.com/Europe/capital-gains-tax
Indexation benefit:
A silent killer lurks in the midst of all our investments. It’s called inflation and it steadily and silently eats into all our returns in real terms of money. And on these diminished returns, one also has to pay capital gains tax. In order to give concession to the tax payers, indexation benefit is provided.
The basis of this concept is that inflation eats into returns and so tax should only be paid on the real part of gains. Based on this, investors have the option of paying long-term capital gains at the rate of lower tax rate with indexation benefits. There is also the option of paying a flat long-term capital gains tax of higher tax rate and investors can choose either option that is more favorable.
The indexation factor is worked out using the consumer price index (CPI) as given below:
*period could be the month or quarter or year, as per your country of taxation.
Example: Mr. A bought a house for $100,000 in May 2005. After 10 years had elapsed, he sold off his house $ 300,000 in January 2015.
CPI for May 2005 and January 2015 are 194.4 and 233.70 respectively.
Indexation factor = 233.70 / 194.40 = 1.203 (approx.)
Indexed cost of acquisition of house = $100,000 X 1.203 = $120,300
Capital Gain = Sale Price — indexed cost of acquisition = $300,000 — $120,300 = $179,700
Capital gain tax has to be paid on the capital gain of $179,700. However, this tax can be evaded if certain conditions are met.
Exemptions in Capital Gain Tax:
Most of the countries encourage investment in capital assets. Hence, Capital Gain Tax is exempt in case, investment is made in qualifiable capital assets with the sale proceeds within a stipulated time from the sale date.
Whenever we are planning to sell the house, it is essential to know the available exemption benefits to reduce the tax impact.
Tax evasion is a crime but tax avoidance is legitimately allowed.
Hope this article provides some insights about Capital Gain.
