Should You Reinvest Long-Term Capital Gains from Property into Sec54EC Bonds or Market Instruments?
When we sell property and make a substantial profit (after indexation of course), the question of what to do with your long-term capital gains (LTCG) becomes crucial. We have the option to reinvest gains another residential property, or into Sec54EC bonds or pay the LTCG tax and invest the remaining amount into market instruments. This decision can significantly impact your financial outcomes. In this blog, I want to talk about a case where you do not want to reinvest into another residential property. I wanted to blog this because, almost everyone assumes the only thing to do with capital gains if you don't buy another property, is to buy capital bonds. This is an attempt to clearly articulate with logic and numbers what the outcome is if you examine other options.
Understanding the Options
Scenario 1: Investing INR 50 Lakhs in Sec54EC Bonds
Sec54EC bonds are government-backed bonds specifically designed for reinvesting LTCG from property sales to avail tax exemptions. These bonds have a lock-in period of five years and offer an annual interest rate of 5.25%, which is taxable. This rate may change, but for now this is the prevailing rate. Usually these bonds are issued by IRFC, NHAI, PFC, and REC and are AAA rated, so they are highly secure. They also require the investor to be locked in for 5 years - which means you will have no access to those funds. Oh, and you can only invest a maximum of 50 Lakhs per person in such bonds in a fiscal year. These bonds need to be bought within 6 months of realizing the capital gains.
Principal Amount | Annual Coupon Rate | Lock-in Period | Annual Interest Earned | Tax on Interest (30% bracket) | Net Annual Interest Earned |
INR 50 Lakhs | 5.25% | 5 years | INR 2,62,500 | INR 78,750 | INR 1,83,750 |
To make our comparison more equitable, we will assume that this annual interest earned (After tax), then is reinvested into a FD or Recurring deposit at 7%. So at the end of 5 years, we will have INR 50 Lakhs that matures from the bonds, and total post tax income of INR 10,51,313/-
Scenario 2: Reinvesting After Paying LTCG Tax
Alternatively, you can choose to pay the LTCG tax and reinvest the remaining amount into market instruments such as mutual funds, stocks, or other investment options that could potentially offer higher returns.
Capital Gains | LTCG Tax Rate | Tax Payable | Amount Available for Reinvestment |
INR 50 Lakhs | 20% | INR 10 Lakhs | INR 40 Lakhs |
Let's consider different scenarios with varying returns, where we will also assume the money invested compounds annually.
Scenario | Annual Return | Total Amount After 5 Years (Compounded) | Income | Post-Tax Income (Excluding Principal) |
A | 8% | ₹ 58,77,312 | ₹ 18,77,312 | ₹ 16,89,581 |
B | 12% | ₹ 70,49,367 | ₹ 30,49,367 | ₹ 27,44,430 |
C | 15% | ₹ 80,45,429 | ₹ 40,45,429 | ₹ 36,40,886 |
D (Debt/FDs) | 7% | ₹ 56,10,207 | ₹ 16,10,207 | ₹ 11,27,145 |
Comparing the Outcomes
If we see where we would stand after 5 years, assuming we redeem/cash out these investments :
Investment Option | Cash in hand after 5 years (after tax) |
Sec54EC Bonds (5.25% Interest) | ₹ 60,15,313 |
Market Instruments (Equity) | |
8% Return | ₹ 56,89,581 |
12% Return | ₹ 67,44,430 |
15% Return | ₹ 76,40,886 |
Debt/FDs (7% Return) | ₹ 51,27,145 |
So what should we do?
Choosing between Sec54EC bonds and market instruments depends on your risk appetite, need for liquid funds and confidence in disciplined investing.
Sec54EC bonds offer a safe, tax-saving investment with moderate returns. In contrast, market instruments have the potential for higher returns but come with greater risk.
If you want to optimize taxes and minimize risk, the Sec 54EC bonds are clearly the way to go, especially if you reinvest the interest - after all money making more money is the way you grow weath. It makes no logical sense to pay capital gains tax and park those funds in FDs or debt funds if you are in any taxbracket over 10%, unless you feel there is a need to have access to the funds. Remember that capital bonds are illiquid for 5 years.
For those who are interested, at what rate of returns (Assuming 10% taxation), should we invest in the market to make paying the capital gains a viable option? Anything over 8.04% will give you returns above the Capital Bond scheme, and you will also have the added advantage of access to the funds when you need it.
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