Are Capital gain Bonds worth buying to save capital gains tax?

are capital gain bonds worth investing

Capital gain bonds are used to save long-term capital gain tax on the sale of property (Residential or non-residential). But at the time of rising stock market scenario, one question always crop up in the mind of Investors, as to if they should Invest in Capital gain bonds or Pay tax and Invest the balance in shares or Mutual funds. This is with expectations that money will remain liquid and also will generate more as compared to capital gain bonds which has an interest rate of 5.75% and that too taxable.

These kinds of queries have been increased post demonetization especially from those who were lucky enough to sell their properties before 8th November 2016. Though they have another option too to save long-term capital gain tax on the sale of property by buying another residential house within next 2 years or constructing a residential house in next 3 years of sale of property, but they do not want to buy another Real estate …at least for now.

Now, to decide if they should buy capital gain bonds or not, let’s first understand what these capital gain bonds are and how they work, in brief?

What are capital gain bonds and how they work?

When you sell a property, be it commercial, residential or even Plot, then whatever gain comes out of that transaction is termed as Capital gains since the property is a capital asset.

Now depending on the holding period of that capital asset i.e. the time you have held that asset, before selling it, gain from the same, is termed as the Long term or short-term capital gain.

As per Income tax laws, the minimum holding period to qualify real asset as long term is 2 years (w.e.f April 1. 2018, as proposed in Budget 2017), means if you sell the property after April 1, 2018, then the minimum holding period would be 2 years, but if you have sold the property in 2017 then the required holding period to qualify the transaction as long-term was 3 years.

Short term capital gain will be added to your total income and will be taxed as per your Income tax slabs, whereas Long term capital gain on a property will be taxed as 20% after providing for indexation benefit.

There are various ways with which you can save capital gain tax on the sale of property, and buying Capital gain bonds is one of those.

Capital gain bonds are the eligible financial instruments under section 54EC, in which investor can invest the capital gain amount or the entire sale proceeds, as the case may be and save oneself from paying any long-term capital gain tax on the sale of the property. Investment has to be made within 6 months from the date of sale.

These bonds are issued by NHAI (National Highway Authority of India) and REC (Rural Electrification Corporation).

There is a lock-in period of 5 years(W.e.f 1 April 2018) and the current rate of Interest is 5.75% per annum payable annually (Taxable). The maximum you can invest is Rs 50 lakh.

In Budget 2017, Finance Minister has proposed to come up with more bonds or financial Instruments to save long-term capital gain tax on the sale of the property.

Seeing the low-interest rates and that too taxable, one generally gets reluctant to invest the money generated from the growing real estate, and look out for other options available. Another alternative is to pay tax and invest money in another growing asset like equity. But, would that be feasible, let’s do some maths to find out.

Capital gain bonds Vs. Investment elsewhere

Income tax rates
10% 20% 30%
Capital gain to be invested 5000000 5000000 5000000 5000000
ROI on Capiital gain Bonds 5.75% 5.75% 5.75% 5.75%
Annual Interest 287500 258750 230000 201250
Assumed FD Rate 7% 6.30% 5.60% 4.90%
5 year interest 1467360 1286217 1109814
Maturity (Bonds capital + FD) 6467360 6286217 6109814
Option2
Investible surplus Post CG tax 4000000 4000000 4000000
Maturity value on Bonds 6467360 6286217 6109814
Post-tax ROI desired 10.09% 9.46% 8.84%

Just to make calculation simpler, I have taken Capital gain after Indexation amount to be Rs 50 lakh only so the full amount can be invested and should be under the maximum limit of capital gain bonds. I have assumed that the annual interest from Bonds is being reinvested in bank Fixed deposits which have ROI as 7%. FD interests are compounded quarterly, but I have taken annual compounding. Also, the education cess on Income tax is ignored.

What the above table shows is that If someone invests the complete capital gain/sale proceeds in capital gain bonds and also keep reinvesting the Annual interest in bank FD then the post-tax maturity value would be 64.67 lakh, 62.86 lakh and 61.09 lakh for someone in 10%, 20% or 30% tax bracket respectively.

Option 2 in the second table shows that if you pay capital gain tax and invest the money somewhere else, then how much return your investment should generate to beat the returns from capital gain bonds investments?

Conclusion – Should you invest In capital gain Bonds?

It is quite evident from the above calculations that how much investor needs to generate from other investments, to compare it with the bond investments.

The desired ROI may not look that difficult to achieve, but since the shares and mutual funds are not fixed return instruments and are market-linked products, so there is considerable risk involved in the complete transaction.

If one is comfortable with the volatility and agrees to accept the inherent risk, then one may go with the paying tax and invest options, else capital gain bonds will be suitable.

Moreover investing always should commensurate with your goal requirements and tax planning should be part of your holistic financial plan.

Sometimes it is desirable to take the risk if the money is to be invested for a very long-term horizon, and sometimes it is not advisable to take such risks as the goal is nearby and you have enough money for that goal. So, one has to decide accordingly.

Hope this article would help in making the decision to buy capital gain bonds or pay long-term capital gain tax and invest money elsewhere. Share your views and queries in the comments section below.

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8 COMMENTS

  1. Simply it means that as long as you are sure that you would be able to generate an ROI of 12.88 to 10.63 (depending upon your tax bracket), it makes sense to pay CG upfront and invest money in such high yield avenues.
    Very simple, nice and easy to understand analysis.

    • Yes, but it all depends on case to case basis. If all the data falls as per the example, then the rates of 12.88 – 10.63 applies. This article is to show what needs to look at before taking any decision.

    • Hello Sir,
      I own a land in Hyderabad purchased in 2003, planning to sell within few months. I am keen to save entire CGT by investing in 54EC bonds. Your article provides useful information on this matter. My specific question is to further clarify “can invest the capital gain amount or the entire sale proceeds”. Do I need to invest the entire sale proceed in 54EC bonds to save entire CG? Or Can I invest only the capital gain amount?

  2. Very good analysis… One question – After selling property – can we invest part of long term capital gain in NHAI/REC bonds and on remaining amount – pay LTCG tax proportionately ?

  3. My mother sold a land and there is LTCG incurred:
    Is it possible that me or my wife become the first applicant & my mother second while buying Capital Gain Bond (NHAI/REC) and still my mother can claim capital gain exemption?

  4. Very Good advise given I too had sold my property in 2014 after purchasing it in 2005 . I invested in NHAI 54 EC bonds and I had an very good experience with NHAI. I had selected demat form of deposit . Received all interests on time and final interest and principle on the 28 February 2018 .A very pleasant experience with Government of India and National Highways Authority of India NHAI.
    THANK YOU NHAI we had good relationship. My citizens of India should be encouraged and feel positive to invest in Government Sponsored schemes . I have had an positive experience with NHAI. Thank You NHAI once More .

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