Real Estate Taxation

Gains or Losses that arise from the sale of any capital asset like property, shares, securities, gold etc are subject to capital gains tax under the provisions of the Income-tax Act. No implication on purchase of property under Income tax.

Overview of taxation on sale of property

Gains or Losses that arise from the sale of any capital asset such as property, shares, securities, gold, etc. are subject to capital gains tax under the provisions of the Income-tax Act. There are no implications in the Income-tax Act upon purchase of a property.

Nature of capital gains

If the property is held for 36 months or less, the resultant gain is called Short-term Capital gains. If the property is held for more than 36 months, the gain is referred to as long-term capital gain. The short-term capital gain is taxed at the normal rate of tax (i.e., at slab rates for individuals and 30% for companies) while the long term is taxed at 20%, subject to certain conditions.

Let’s now look at how to compute capital gains.

Computation of Capital Gains

The basic format for the calculation of capital gains is laid out in Table 1.

Maximising returns

Maximising returns for a given risk

The simple truth in investment is that there is no such thing as a low-risk high-return opportunity. It is a myth and we must be careful about it. The golden rule is that returns are proportional to risk. If you invest in a risk-free instrument, such as Government bonds, your return will be around the rate of inflation. The return you get is really just the time value of money.

By opting for high quality AAA rated corporate bond, your returns are higher; but you are taking on the additional risk, albeit minimal, of default by the issuer. And if you choose lower rating bonds such as AA or A rated ones, the returns tend to increase, along with the risks. The key really is to understand the risks, know what is suitable for you as an investor and find the investment that gives the best return for your specific risk appetite.

In the case of equity investments, investors demand higher return than what they expect from debt instruments, as the risks are perceived to be higher. For instance, the price of a stock may be volatile due to local political factors, market fluctuations, global turbulence as well as sector and company specific issues. A successful investor weighs the risks and chooses to enter into a trade only if the estimated returns are acceptable.

This is not to say that the market is very rational. Mis-pricing happens all the time as investors become risk averse – they demand high returns even for a small risk. In contrast there will be times when prices are beaten down. Anyone who picks up the bargain when the mood is negative can earn good returns once the mood turns optimistic. Equity analysts and experts who can identify which risks are real and priced in, which are not real but priced in, can help identify such opportunities.

The same logic applies to investments in real assets such as property. When you buy a completed home, there may be limited risks, as property prices do not tend to fall substantially in the Indian markets. One can earn a rental yield of 3 per cent annually. Add capital gains of 4-5 per cent every year, the investor can hope to earn returns inline with inflation.

By investing in an under-construction home, you take on additional risk – of delays, quality and other changes that may happen during the duration of the project. Hence you would expect higher returns. The risks in the investment can be assessed and mitigated by evaluating developers on various parameters such as delivery and quality track record.

Likewise, investing in the pre-launch stage and exiting when the developer launches the project to the wider market can deliver higher returns. The risks may also be high – plan approvals may not be received and the market may not perceive the project as interesting. These risks are in addition to location specific supply-demand dynamic changes, but all of these can be evaluated and priced. In fact, many high net-worth investors (HNIs) evaluate the developer and the project and profit from taking calculated bets.

So, investors have to assess each investment choice with the yard stick of risk and return. You must build your overall investment portfolio with debt, equity and alternate investments, to maximise risk-adjusted returns for a given level of risk. The asset allocation must be adjusted periodically as the market shifts. This is the best way to build long-term wealth.

Property as a financial asset

Property as a financial asset

Real estate as an investment option is falling out of favour. While a few factors such as oversupply and the black money bill have been cited as the reasons for the cyclical downturn, fundamentally property as an asset class is maturing in the country. From being an opaque market with inefficiencies, the industry has been slowly changing in the last decade, thanks to institutional capital which is bringing in professionalism and transparency.

In the past, homes were built for consumption only and not as an investment. Homes were also self-constructed and there were no large scale projects. With real estate industry picking up, there was a need for capital. Property developers looked to investors to raise money, as traditional funding sources such as banks and NBFCs were not always willing to lend to, especially during the early stages of a project.

As an alternative to money lenders, larger developers went with real estate private equity funds. They were all the rage in the mid 2000s and many foreign and local funds were launched. They offered funding in two models – equity and debt. Equity oriented funds provide money in the early stage and when the property is sold, get their returns by way of price appreciation. Debt oriented funds offer loans in any stage to be repaid with interest (ranging from 18 to 25 per cent annually) after a certain period. There are also hybrid funds where the developer pays an assured minimum return plus a share of the price appreciation.

While it was a good deal for developers, many foreign funds and those that invested in commercial property such as office buildings, malls and retail space were stuck as they could not sell their stake. There was a shake up and many funds shut shop – the number of funds is now down to about 10, from 50 in the go-go days of 2007.

Among those left standing are local funds with a focus on residential real estate. Their strengths include offering thorough diligence on the builder and the project. They also monitor progress, put in systems to ensure quality and on-time delivery – all to ensure they can earn their return. Home buyers and developers also benefit in this bargain.

These methods have worked and the funds have been able to earn healthy returns even when the market was beaten down. The case in point is ASK Investment, a real estate private equity fund. They had at least four exits from the residential segment investments at multiples of 2.25 to 2.5 times in about four years. These work out to annual returns of 20 to 25 per cent – not a bad deal for any investment.

So while investors who bought physical property were stuck with low returns and inability to exit, wealthy investors who took the financial ownership route through real estate PE funds were laughing on their way to the bank. Real estate PE funds also offer diversification benefits as they invest in different geographies. Based on the risks assessed for the project and developer, the returns are set and systems are put in place to reduce issues.

The main disadvantage of the PE funds however is that they need a large corpus – the minimum investment is Rs 1 crore, as per SEBI regulations. Money flow to these funds increased over 20 per cent in 2015, after doubling in 2014.

Making the residential property market more institutionalised – with more economic ownership choices for investors big and small – will only help the system further.

Real Estate Bill

Is this one finally for real?

If you have been one of those teeming millions taken for a ride by builders, here is some hope.

The Real Estate Act, 2016 has been passed by the two houses of parliament and received presidential assent. That it should have taken so many years since it was first introduced in parliament is a tad sad, but “it’s better late than never.”

The Act is welcome because it protects buyers by offering them TEA: transparency, efficiency and accountability in the execution of real estate projects. No one is saying that promoters are crooks but there have been rank inefficiencies even amongst the best of them, and there were no sufficient distress redressal mechanisms.

Here are TWELVE important things that you should know about the new Act.

1. Real Estate Regulatory Authority

If you have a grouse, you can lodge your complaints with the proposed “Real Estate Regulatory Authority (RERA).” This body will be set up within one year from the date of commencement of this Act. Until then there will be a stand-by body.

2 Registration

  1. Every promoter has to register his project, whether residential or commercial, with RERA before booking, selling or offering apartments for sale.

  2. In respect of projects ongoing on the date of commencement of the Act, and which have not received a completion certificate, the promoter shall apply for registration within three months of the start of the Act.

  3. The following projects do not require registration:

  1. Where the land area to be promoted does not exceed 500 square meters or the number of apartments to be constructed does not exceed eight apartments.

  2. Projects where the completion certificate has been received before the commencement of the Act;

This is the first step towards building Accountability.

3 Carpet Area

A marked departure from the past is that developers can sell units only on carpet area. This would essentially mean that the quote will be per unit of carpet area.

Carpet area is the net usable floor area of an apartment. This excludes the area covered by the external walls and common area. Typically in high-rise buildings, 30% of the area is the common area. Thus, if you are buying a property of 2000 square feet at say Rs 7500 per square feet, you will be paying Rs 150 lac. But in reality, you would be paying that amount for about 1700 square feet of livable area, which translates to Rs 8823/-. Yes, this does not mean much to the buyer, but it, at least, gives him the true cost of purchase.

This is a clear step towards Transparency.

4 Separate bank account

  1. The promoter will have to deposit 70% of the amount received from buyers in a separate bank account. This money will have to be used only towards the cost of land and construction of this specific project.

  2. The promoter can withdraw the money in proportion to the percentage of completion of the project. Such drawings can be made only after a CA certifies that the withdrawal is in proportion to the percentage of completion of the project.

  3. The promoter must get his accounts audited by a CA within six months of the closure of the financial year.

This is a step towards efficiency.

5 Acceptance of registration

  1. RERA shall within 30 days, grant or reject the registration, failing which the project shall be deemed to be registered.

  2. Upon granting a registration, the promoter will be provided with a registration number, including a login Id and password for accessing the website of RERA and to create his web page and to fill in complete details of the project.

This is a step towards efficiency.

6. Website of RERA

The promoter shall, upon receiving his login Id and password, create his web page on the Internet site of the Regulatory Authority and enter all details of the proposed project including providing quarterly updates on the status of the project.

This is a step towards transparency.

7. Revocation or lapse of registration

RERA can revoke registration if the promoter defaults in doing anything required under the Act. If the registration is canceled or it lapses, RERA shall:

  1. Debar the promoter from accessing the website about the project.

  2. Specify his name in the list of defaulters on its internet site.

  3. Inform other Regulatory Authorities in other States and Union territories about such cancellation.

  4. Facilitate the remaining development works to be carried out by competent authority.

  5. Direct the bank holding the project bank account, to freeze the account.

This is a step towards accountability.

8 Marketing by the promoter

  1. The advertisement or prospectus published by the promoter should prominently mention the website address of the RERA.

  2. Where any person makes an advance on the basis of the information contained in the advertisement or prospectus and sustains any loss because of any incorrect statement included in these, he shall be suitably compensated by the promoter.

This is a step towards accountability.

9 Maximum advance payment

A promoter shall not accept a sum more than 10% percent of the cost of the apartment or building, as advance payment or application fee, from a person without first entering into a written agreement of sale with such person and register the said agreement of sale.

This is a step towards efficiency.

10 Alteration in the plans

  1. The promoter cannot add or alter the approved and sanctioned plans, without the previous written consent of at least two-thirds of the allottees.

  2. The promoter shall make good without any further charge any defect in workmanship or obligations brought to his notice at any point within a period of five years from the date of handing over possession.

    This is a step towards efficiency.

11. Delay in handing over possession

If the promoter is unable to hand over possession to the allottee in accordance with the terms of the agreement, he shall on demand being made by the allottee, to return the amount received by him from the allottee with interest and compensation at the rate and manner as provided under the Act.

This is a step towards accountability.

12. Other provisions

  1. The same rate of interest will be payable by the allottee and the promoter in the event of their respective defaults.

  2. After the promoter executes an agreement for sale no charge can be created by the promoter on such property.

  3. The promoter shall insure the land and building and construction of the project and pay the necessary premium.

  4. The promoter shall compensate the allottees in the case of any loss caused to him due to a defective title of the land.

  5. Allottees must take physical possession within two months of the occupancy certificate issued for the said apartment.

These provisions are likely to bring in greater transparency, efficiency and accountability in the execution of real estate projects and act as win-win for both parties. It also would inject a lot more of professionalism into the industry.