Section 54EC bonds allow you a deduction from the capital gains you have made. In return, your money is locked in for five years at 5.25%. How do they stack up against the alternatives?
If you have sold real estate, after a two-year holding period, you may have incurred a long-term capital gain. This is ordinarily taxed at 20% with the benefit of indexation. However, you can reduce the tax you have to pay by reinvesting the proceeds in Section 54EC bonds. These bonds are issued by the National Highways Authority of India (NHAI) and Rural Electrification Corporation (REC), both of which are public sector bodies. The deduction under these bonds is not available if you have sold your property within two years of purchase (short-term capital gain).
You can invest up to Rs 50 lakh in these bonds to get the deduction. At a 20% tax rate (without applying indexation), this will save you about Rs 10 lakh in tax. Typically, due to indexation, the tax saving will be lower. Where the asset is jointly owned, both partners will get separate limits of Rs 50 lakh for their share of the gains, effectively doubling the limit to Rs 1 crore.
The 54EC deduction has been restricted by Budget 2018 to real estate only, while prior to this, long capital gains from the sale of any long-term capital asset could have been set off against investing in section 54EC bonds. Thus gains on unlisted bonds, shares or debt mutual funds or even equity mutual funds cannot get the benefit of this deduction. Also, you cannot exit from these bonds within five years of purchase. This was earlier three years but has been extended by Budget 2018. Note, however, that the five-year lock-in and also the exemption coverage will go into effect on 1st April 2019 only rather than in the coming financial year.
Section 54EC bonds currently carry an interest rate of 5.25%. This interest is taxable. In other words, if you are in the 30% tax bracket, you will get an effective interest rate of 3.67% per annum.
Budget 2018: Section 54EC restricted to gains only from real estate; holding made 5 years
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