When I met one of my friends last week, he was very happy that he is making a huge profit on one of his property investments. He bought a 3BHK Flat in Bangalore in 2012. He purchased the property for Rs 50 Lakhs (including registration & brokerage charges). Now, he is reselling it for Rs 80 Lakhs. The holding period is less than 3 years.
The expected profit from this transaction is around Rs 30 Lakh. That’s a decent 26.5% pa returns (CAGR) in 2 years. But, is that so simple to calculate the net profit? The profit made from the sale of property is never a simple calculation involving the subtraction of ‘Purchase Price’ from ‘Sale Price.’
We need to consider income-tax rules before arriving at the actual profit to be made.
1) Interest paid on Home Loan Amount
I f you had taken a home loan then you need to calculate the total interest paid for the holding period.This is an expense.We need to subtract this amount from the expected profit.
Let us assume that my friend has taken a home loan of Rs 40 Lakh. Loan tenure is 20 years. The interest rate is 10.5%. The EMI (Equated Monthly Installment) is Rs 39,935. EMI has two components, Interest and second one is Principal component.
The total interest repayment in the last 2 years in his case (2012 to 2014) was Rs 7,93,375.
2) Principal Amount Repayment on Home Loan
This point is applicable if you had claimed the Principal component of EMI under Section 80c.
If the property is sold within five years of buying then the tax deduction benefits that you have claimed in the previous years are reversed. That means, the total principal amount claimed in the last two years under Section 80c will be added back to your salary.
In the above case, the total Principal amount claimed as tax deduction for two years was Rs 1,25,134. This amount is added to your salary/income. As per your income tax slab, you need to pay tax on this amount too. So, the profit on sale transaction would still come down.
3) Tax on Short Term Capital Gains
If you sell a property after 36 months of buying it, you may realize ‘Long Term Capital Gains.’ If you sell a property within 36 months of buying it, you get ‘Short Term Capital Gains.’
In the above case, my friend is planning to sell the property within 3 years, so he is making short term capital gains from the transaction.
If you sell a property within 36 months of buying it, the profit is added to your income for that year, and taxed as per your income tax slab rate.
Let us now calculate the actual final gain, after considering the above charges and tax liability.
- In the above example, my friend may get returns of around 14% pa from this transaction. But, do not invest in real estate investments for quick short term gains. It is unrealistic to expect these kind of returns in short term.
- If you invest for short term gains then you may have to face the Liquidity risk
- Do not get carried away by stories of friends or colleagues who made lakhs within a year of property investment.
- It is advisable to stick to your investment for the long term.
- Do your calculations before selling your property if it is within 3 years of buying.
Home Loan – Total Interest & Principal Repayments Calculator
You may use the below calculator to calculate the total interest / principal repayments of a specific duration.
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