Section 54EC Bonds: Deduction on LTCG Through Capital Gain Bonds

Section 54EC Bonds: Deduction on LTCG Through Capital Gain Bonds. Capital gains tax is applicable when a taxpayer sells a long-term capital asset such as land or building at a profit. However, under the Income Tax Act of India, certain provisions allow taxpayers to claim exemptions from this tax liability. One of the most important among them is Section 54EC, which provides relief from long-term capital gains (LTCG) arising from the transfer of immovable property. This relief is available when the gains are reinvested in specific bonds known as Section 54EC bonds. These bonds are issued by notified government-backed institutions and are designed to promote infrastructure development.
Bonds Eligible to Claim Exemption under Section 54EC
Only bonds notified by the Central Government qualify for exemption under Section 54EC. These include bonds issued by the following institutions:

Rural Electrification Corporation Limited (REC)
National Highway Authority of India (NHAI)
Power Finance Corporation Limited (PFC)
Indian Railway Finance Corporation (IRFC)

These are fixed-income instruments backed by the government, making them safe and low-risk investments. The interest earned on these bonds is taxable, but the capital gains reinvested in them are exempt up to a specified limit.
Eligibility for Claiming Deduction Under Section 54EC
The following conditions must be met to avail of the deduction on LTCG through capital gain bonds:

The taxpayer can be an individual, HUF, company, LLP, partnership firm, or any other entity.
The asset transferred must be a long-term capital asset, specifically land, building, or both.
The asset should have been held for more than 24 months from the date of acquisition.
The taxpayer must reinvest the capital gains in eligible Section 54EC bonds within 6 months from the date of the transfer of the property.
The maximum investment allowed in a financial year and the immediately following financial year is Rs. 50 lakhs in total.
The bonds must be held for a minimum lock-in period of 5 years. They cannot be sold, pledged, or used as collateral during this period.

Important Facts to Know While Claiming Deduction on LTCG Through Capital Gain Bonds

Investment must strictly be done within six months from the date of sale of immovable property.
Earlier, these bonds had a lock-in period of 3 years, but from April 2018, the lock-in has been extended to 5 years.
The benefit is available only for capital gains arising from the sale of immovable property and not for any other capital assets.
The maximum amount that can be claimed as exemption under Section 54EC is Rs. 50 lakh, even if the actual capital gain is higher.
If the bonds are encashed or transferred before the 5-year maturity, the amount that was earlier exempt will become taxable in the year of conversion.

How to Calculate the Deduction under Section 54EC?
Let us understand how the deduction is calculated using practical examples.
Example 1: Suppose a property is sold for Rs. 70 lakh after holding it for 42 months. The indexed cost of acquisition is Rs. 46 lakh, and the indexed cost of improvement is Rs. 10 lakh. The capital gain will be:

Sale consideration: Rs. 70 lakh
Less: Indexed cost of acquisition: Rs. 46 lakh
Less: Indexed cost of improvement: Rs. 10 lakh
Long-term capital gain: Rs. 14 lakh

Case I: Investment of Rs. 14 lakh in REC Bonds within 6 months

Exemption claimed under Section 54EC: Rs. 14 lakh
Taxable LTCG: Nil

Case II: Investment of Rs. 8 lakh in NHAI Bonds within 6 months

Exemption claimed under Section 54EC: Rs. 8 lakh
Taxable LTCG: Rs. 6 lakh

Note: If the bonds are prematurely redeemed, say in FY 2023-24, the invested amount (Rs. 8 lakh) becomes taxable LTCG in the year of redemption.
Example 2: Suppose an immovable property is sold for Rs. 90 lakh after a long-term holding of 42 months. The indexed cost of acquisition is Rs. 20 lakh and the indexed cost of improvement is Rs. 10 lakh.

Sale consideration: Rs. 90 lakh
Less: Indexed cost of acquisition: Rs. 20 lakh
Less: Indexed cost of improvement: Rs. 10 lakh
Long-term capital gain: Rs. 60 lakh

Investment of Rs. 50 lakh in REC Bonds within 6 months:

Exemption under Section 54EC: Rs. 50 lakh
Taxable LTCG: Rs. 10 lakh

This example clearly shows that even if the total capital gain is more than Rs. 50 lakh, the exemption is limited to Rs. 50 lakh, the maximum permissible amount under Section 54EC.
How to Invest in Section 54EC Bonds?
Section 54EC bonds are not traded on stock exchanges, which means you cannot buy or sell them through regular market platforms. The investment must be made through authorized banks or institutions. Here's how you can invest:
Step 1: Visit the official website of the issuer (REC, PFC, IRFC).
Step 2: Download the bond application form in ZIP format.
Step 3: Unzip and extract the form, print it, and fill it as per the given instructions.
Step 4: Attach a demand draft or account payee cheque with the filled form.
Step 5: Submit the documents at designated branches of collecting banks like SBI, Axis Bank, Canara Bank, ICICI Bank, HDFC Bank, IDBI Bank, IndusInd Bank, or Yes Bank.
Step 6: Alternatively, you may transfer the amount through NEFT/RTGS into the respective collection account and mention the UTR number in the application form.
Step 7: You can choose to receive the bond in demat or physical form.
Maturity and Interest on 54EC Bonds

The lock-in period is 5 years from the date of investment.
Early redemption or transfer is not allowed before 5 years.
Interest on the bonds is generally around 5% to 6% per annum and is taxable.
Upon maturity, the principal amount is returned to the investor without any tax obligation, as the original capital gain was already exempted.

Benefits of Investing in Section 54EC Bonds

Helps you save LTCG tax by investing the gains.
Being government-backed, these bonds are considered very safe.
Although returns are moderate, they are predictable.
Simple application process through banks.
Not being traded in the open market, the risk of capital loss due to market fluctuations is minimized.

Things to Keep in Mind

Ensure timely investment within 6 months from the property sale.
Keep a copy of the bond certificate or demat statement.
Report the exemption under the correct section in your Income Tax Return.
Do not use these bonds for loans, pledges, or advances.
If you fail to hold the bonds for 5 years, the exemption will be reversed and taxed as LTCG in the year of encashment.

Conclusion
Section 54EC bonds offer an effective route to save on long-term capital gains tax when you sell immovable property. By investing in these capital gain bonds, you not only defer your tax liability but also get a safe, government-backed investment instrument. However, it's important to adhere to all conditions like lock-in period, maximum investment limit, and the 6-month window to ensure you remain eligible for the exemption. With proper planning, this provision under the Income Tax Act can be an important part of your tax-saving and wealth preservation strategy.
Always consult with a tax expert or advisor of Compliance Calendar LLP to ensure compliance and optimize your tax benefits through Section 54EC bonds.
FAQs

What type of capital asset transfer qualifies for the Section 54EC exemption, and what is the deadline for investing the capital gains?

The Section 54EC exemption applies to capital gains arising from the transfer of a long-term capital asset, specifically land or building or both. The capital gains must be invested in the specified bonds within six months from the date of transfer of the original asset.

Who are the eligible assessees that can claim the tax exemption under Section 54EC?

The exemption under Section 54EC can be claimed by Individuals, Hindu Undivided Families (HUFs), Companies, Firms, Limited Liability Partnerships (LLPs), and any other person.

Can you list the specific bonds that are currently notified by the Central Government for investment under Section 54EC, and what is the maximum amount that can be invested in a financial year to claim this exemption?

The specified bonds currently include those issued by the Rural Electrification Corporation Limited (REC), Power Finance Corporation Limited (PFC), Indian Railway Finance Corporation Limited (IRFC), and Housing and Urban Development Corporation Limited (HUDCO). The maximum investment eligible for exemption is ?50 lakhs in a financial year.

What are the key features of the 54EC bonds, particularly regarding their lock-in period, interest rate, and transferability?

The 54EC bonds have a lock-in period of five years, during which they cannot be transferred, converted into money, or used as security for any loan or advance. They typically offer an annual interest rate of 5.25%, payable annually. The interest earned is taxable as per the investor's applicable income tax slab, and the bonds are non-transferable during the lock-in period.

Have there been any recent changes to Section 54EC, and what are the practical steps an individual needs to take to comply with the regulations and claim the exemption in their Income Tax Return?

Yes, the Finance Act, 2018, introduced changes, restricting the exemption to capital gains from the transfer of land or building or both and extending the lock-in period for the specified bonds from three to five years for investments made on or after April 1, 2018. To comply and claim the exemption, individuals need to obtain and retain the bond certificates or receipts as investment proof and report the capital gains and the investment in 54EC bonds in the relevant sections of their Income Tax Return (ITR). If applicable, they should also collect Form 16A for the interest earned, as it is taxable income.

Capital gains tax is applicable when a taxpayer sells a long-term capital asset such as land or building at a profit. However, under the Income Tax Act of India, certain provisions allow taxpayers to claim exemptions from this tax liability. One of the most important among them is Section 54EC, which provides relief from long-term capital gains (LTCG) arising from the transfer of immovable property. This relief is available when the gains are reinvested in specific bonds known as Section 54EC bonds. These bonds are issued by notified government-backed institutions and are designed to promote infrastructure development.

Bonds Eligible to Claim Exemption under Section 54EC

Only bonds notified by the Central Government qualify for exemption under Section 54EC. These include bonds issued by the following institutions:

Rural Electrification Corporation Limited (REC)
National Highway Authority of India (NHAI)
Power Finance Corporation Limited (PFC)
Indian Railway Finance Corporation (IRFC)

Eligibility for Claiming Deduction Under Section 54EC

The following conditions must be met to avail of the deduction on LTCG through capital gain bonds:

The taxpayer can be an individual, HUF, company, LLP, partnership firm, or any other entity.
The asset transferred must be a long-term capital asset, specifically land, building, or both.
The asset should have been held for more than 24 months from the date of acquisition.
The taxpayer must reinvest the capital gains in eligible Section 54EC bonds within 6 months from the date of the transfer of the property.
The maximum investment allowed in a financial year and the immediately following financial year is Rs. 50 lakhs in total.
The bonds must be held for a minimum lock-in period of 5 years. They cannot be sold, pledged, or used as collateral during this period.

Important Facts to Know While Claiming Deduction on LTCG Through Capital Gain Bonds

Investment must strictly be done within six months from the date of sale of immovable property.
Earlier, these bonds had a lock-in period of 3 years, but from April 2018, the lock-in has been extended to 5 years.
The benefit is available only for capital gains arising from the sale of immovable property and not for any other capital assets.
The maximum amount that can be claimed as exemption under Section 54EC is Rs. 50 lakh, even if the actual capital gain is higher.
If the bonds are encashed or transferred before the 5-year maturity, the amount that was earlier exempt will become taxable in the year of conversion.

How to Calculate the Deduction under Section 54EC?

Let us understand how the deduction is calculated using practical examples.

Example 1: Suppose a property is sold for Rs. 70 lakh after holding it for 42 months. The indexed cost of acquisition is Rs. 46 lakh, and the indexed cost of improvement is Rs. 10 lakh. The capital gain will be:

Sale consideration: Rs. 70 lakh
Less: Indexed cost of acquisition: Rs. 46 lakh
Less: Indexed cost of improvement: Rs. 10 lakh
Long-term capital gain: Rs. 14 lakh

Case I: Investment of Rs. 14 lakh in REC Bonds within 6 months

Exemption claimed under Section 54EC: Rs. 14 lakh
Taxable LTCG: Nil

Case II: Investment of Rs. 8 lakh in NHAI Bonds within 6 months

Exemption claimed under Section 54EC: Rs. 8 lakh
Taxable LTCG: Rs. 6 lakh

Note: If the bonds are prematurely redeemed, say in FY 2023-24, the invested amount (Rs. 8 lakh) becomes taxable LTCG in the year of redemption.

Example 2: Suppose an immovable property is sold for Rs. 90 lakh after a long-term holding of 42 months. The indexed cost of acquisition is Rs. 20 lakh and the indexed cost of improvement is Rs. 10 lakh.

Sale consideration: Rs. 90 lakh
Less: Indexed cost of acquisition: Rs. 20 lakh
Less: Indexed cost of improvement: Rs. 10 lakh
Long-term capital gain: Rs. 60 lakh

Investment of Rs. 50 lakh in REC Bonds within 6 months:

Exemption under Section 54EC: Rs. 50 lakh
Taxable LTCG: Rs. 10 lakh

This example clearly shows that even if the total capital gain is more than Rs. 50 lakh, the exemption is limited to Rs. 50 lakh, the maximum permissible amount under Section 54EC.

How to Invest in Section 54EC Bonds?

Section 54EC bonds are not traded on stock exchanges, which means you cannot buy or sell them through regular market platforms. The investment must be made through authorized banks or institutions. Here's how you can invest:

Step 1: Visit the official website of the issuer (REC, PFC, IRFC).

Step 2: Download the bond application form in ZIP format.

Step 3: Unzip and extract the form, print it, and fill it as per the given instructions.

Step 4: Attach a demand draft or account payee cheque with the filled form.

Step 5: Submit the documents at designated branches of collecting banks like SBI, Axis Bank, Canara Bank, ICICI Bank, HDFC Bank, IDBI Bank, IndusInd Bank, or Yes Bank.

Step 6: Alternatively, you may transfer the amount through NEFT/RTGS into the respective collection account and mention the UTR number in the application form.

Step 7: You can choose to receive the bond in demat or physical form.

Maturity and Interest on 54EC Bonds

The lock-in period is 5 years from the date of investment.
Early redemption or transfer is not allowed before 5 years.
Interest on the bonds is generally around 5% to 6% per annum and is taxable.
Upon maturity, the principal amount is returned to the investor without any tax obligation, as the original capital gain was already exempted.

Benefits of Investing in Section 54EC Bonds

Helps you save LTCG tax by investing the gains.
Being government-backed, these bonds are considered very safe.
Although returns are moderate, they are predictable.
Simple application process through banks.
Not being traded in the open market, the risk of capital loss due to market fluctuations is minimized.

Things to Keep in Mind

Ensure timely investment within 6 months from the property sale.
Keep a copy of the bond certificate or demat statement.
Report the exemption under the correct section in your Income Tax Return.
Do not use these bonds for loans, pledges, or advances.
If you fail to hold the bonds for 5 years, the exemption will be reversed and taxed as LTCG in the year of encashment.

Conclusion

Section 54EC bonds offer an effective route to save on long-term capital gains tax when you sell immovable property. By investing in these capital gain bonds, you not only defer your tax liability but also get a safe, government-backed investment instrument. However, it's important to adhere to all conditions like lock-in period, maximum investment limit, and the 6-month window to ensure you remain eligible for the exemption. With proper planning, this provision under the Income Tax Act can be an important part of your tax-saving and wealth preservation strategy.

Always consult with a tax expert or advisor of Compliance Calendar LLP to ensure compliance and optimize your tax benefits through Section 54EC bonds.

FAQs

What type of capital asset transfer qualifies for the Section 54EC exemption, and what is the deadline for investing the capital gains?

Who are the eligible assessees that can claim the tax exemption under Section 54EC?

The exemption under Section 54EC can be claimed by Individuals, Hindu Undivided Families (HUFs), Companies, Firms, Limited Liability Partnerships (LLPs), and any other person.

Can you list the specific bonds that are currently notified by the Central Government for investment under Section 54EC, and what is the maximum amount that can be invested in a financial year to claim this exemption?

What are the key features of the 54EC bonds, particularly regarding their lock-in period, interest rate, and transferability?

Have there been any recent changes to Section 54EC, and what are the practical steps an individual needs to take to comply with the regulations and claim the exemption in their Income Tax Return?