Sold your property? Should you invest in Section 54EC bonds to save capital gains tax?
If you’ve sold property and want to save on capital gains tax, 54EC bonds may help if you’re okay with low returns, capital protection, and a lock-in period.
If you’ve recently sold a property and are looking to preserve capital while reducing your tax liability, 54EC bonds could be an option. These tax-saving instruments offer exemption from long-term capital gains (LTCG) tax under Section 54EC of the Income Tax Act, 1961.
Designed specifically for reinvesting capital gains, 54EC bonds are a popular choice for those looking to protect profits and avoid hefty taxes after selling real estate or other long-term assets. Experts say they’re suitable if you’re comfortable with low returns, capital protection, and a lock-in period.
“These bonds are issued by specified institutions, such as the National Highways Authority of India (NHAI) or the Rural Electrification Corporation (REC), to finance infrastructure projects. By investing in these bonds, individuals can claim exemption from LTCG tax on the sale of certain assets, like land or buildings,” says Saurabh Bansal, founder, Finatwork Investment Advisor, a SEBI RIA (Registered Investment Advisor).
How do 54EC bonds work?
The key features of 54EC bonds include a lock-in period of five years, during which the investment cannot be redeemed. Investors can invest up to ₹50 lakh in these bonds in a financial year. These bonds typically offer an interest rate of around 5–6 per cent per annum, which is fully taxable as per the investor's income tax slab. The primary attraction of 54EC bonds lies in their tax benefits; they provide an exemption from long-term capital gains (LTCG) tax under Section 54EC of the Income Tax Act, making them a preferred choice for those looking to preserve capital and reduce tax liability after the sale of property or other long-term assets.
How investing long term capital gains in 54EC bonds help save tax
Let’s say Kumar sells a property and makes a long-term capital gain of ₹50 lakh. To avoid paying LTCG tax, Kumar invests the entire capital gain of ₹50 lakhs in Section 54EC bonds. Assuming an interest rate of 5.25 per cent per annum and a LTCG tax rate of 12.5 per cent (post Budget 2024), here’s how it impacts his finances over the 5-year lock-in period.
From year 1 to year 5, Kumar earns interest on the bonds, which is taxable. The interest earned each year would be ₹2.625 lakh (5.25 per cent of ₹50 lakhs). He will have to pay tax on this interest income annually. Since the bonds come with a lock-in, he cannot redeem them before the 5-year period ends. After 5 years, Kumar will get back his principal amount of ₹50 lakh.
By investing in 54EC bonds, Kumar saves ₹6.25 lakh in LTCG tax (12.5 per cent of ₹50 lakhs) and also earns regular interest income over the lock-in period.
“Section 54EC bonds can be a useful investment option for individuals looking to save tax on long-term capital gains. While the interest rate may not be exceptionally high, the tax benefits and regular income can make it an attractive option for those with long-term capital gains. However, it's essential to consider the lock-in period and other terms before investing,” says Bansal.
The other option: Paying tax and investing the post-tax amount
On the other hand, if the same homeowner decides to pay the LTCG tax and invest the post-tax amount in other options such as mutual funds, equities, or fixed deposits, the outcome would differ significantly.
“Mutual funds and equities can offer higher returns, especially over the long term, but they come with higher market risk. They also provide much greater liquidity, allowing access to funds when needed,” says Amit Prakash Singh, co-founder and chief business officer, Urban Money.
Fixed deposits, while safer, offer returns similar to or slightly better than 54EC bonds, with the added advantage of flexibility in tenure and access. Additionally, given the bond’s fixed interest rate, the returns on the bonds may become less attractive when return rates increase significantly or in case of rise in inflation, the actual returns may be impacted significantly.
“Hence, one has to check his financial preferences, risk appetite and future returns before deciding on where to invest,” says Singh.
“Choose 54EC bonds if your goal is capital protection plus tax saving and you’re OK with lower returns and a lock-in. Choose post-tax investing if you're comfortable with market-linked returns, want higher growth and flexibility, and can absorb some risk,” says Deepak Kumar Jain, founder and CEO, TaxManager.in, the tax advisory and e-filing portal platform.
Can 54EC bonds fund your retirement?
“Yes, a retiree can use 54EC bonds to preserve wealth, especially after selling a long-held property, but whether the interest income is sufficient for living expenses depends heavily on their lifestyle, total corpus, and other income sources,” says Jain.
With investment of ₹50 lakh in 54EC and earning ₹2.75 lakh annually as interest income which is ₹20,800 per month effectively. After tax @30% it comes down to ₹14,600 per month. Is that enough in today’s time?
Also Read: 5 things NRIs should keep in mind before investing in property in India
“In an urban setup anything between ₹14,000 to ₹20,000 cannot be enough taking medical needs into account. Yes, this would work when a retiree’s primary goal is capital preservation and tax savings and if he has pension or PF or rental income to support his regular and other expenses,” adds Jain.
Anagh Pal is a personal finance expert who writes on real estate, tax, insurance, mutual funds and other topics
