Fernandes: Sale of Second Flat and 54EC
Ms. Fernandes, 52, took voluntary retirement from a manufacturing firm. She owns her primary flat and is selling a second apartment for ₹85 lakh. The apartment was bought in 2011; for this question assume her indexed cost of acquisition is ₹35 lakh, indexed cost of improvement ₹12 lakh, and transfer expenses ₹1.5 lakh. She also received gratuity ₹18 lakh and leave encashment ₹6 lakh from her non-government employer. She has no pension and wants to convert the sale proceeds into retirement income starting next year. A bank offers section 54EC bonds with a 6% coupon, 5-year lock-in, and a ₹50 lakh annual investment limit; property LTCG is taxed at 20% after indexation. She needs ₹2 lakh a year after tax from the reinvested amount. She is in the 30% slab and uses the old tax regime.
1. Compute the LTCG and tax if she does not reinvest. Then state how much she can defer under section 54EC.
Read the worked answer
LTCG calculation:
- Sale price: ₹85.0 lakh
- Less indexed cost of acquisition: ₹35.0 lakh
- Less indexed cost of improvement: ₹12.0 lakh
- Less transfer expenses: ₹1.5 lakh
- LTCG = ₹36.5 lakh
Tax at 20% = ₹7.3 lakh. Add cess at 4% = ₹0.292 lakh, so approximate tax = ₹7.59 lakh. Net proceeds after tax ≈ ₹77.41 lakh, but only ₹36.5 lakh is the gain.
Section 54EC applies to long-term gains on land or building. The annual limit is ₹50 lakh, so she can invest the entire ₹36.5 lakh in eligible bonds and defer the ₹7.3 lakh tax. The deferral is not exemption: her cost in the bonds is reduced by the deferred gain, so tax returns on sale or maturity. The 5-year lock-in means the money is not available for income or emergencies during that period.
2. Evaluate whether she should use 54EC or pay the tax and invest for income.
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Compare after-tax income and liquidity, not just tax saved.
54EC route: ₹36.5 lakh at 6% = ₹2.19 lakh pre-tax interest. At a 30% slab, after-tax ≈ ₹1.53 lakh. The ₹7.3 lakh tax is deferred, but the capital is locked for 5 years and the coupon is taxable.
Pay-tax route: Tax of ₹7.59 lakh leaves about ₹28.91 lakh from the gain. If invested at 7.5% pre-tax, income = ₹2.17 lakh; after tax ≈ ₹1.52 lakh. The capital remains liquid and diversified.
The income difference is small. 54EC gives capital protection and tax deferral, but it does not meet her ₹2 lakh after-tax target by itself. A sensible judgement is to use 54EC only for the portion she is sure she will not need for five years, and keep the rest liquid. If she needs income now, paying tax and using a diversified income portfolio may be better despite the immediate tax cost.
3. Explain the tax treatment of the gratuity and leave encashment.
Read the worked answer
For a non-government employee retiring from employment:
- Gratuity: exempt under section 10(10) up to ₹20 lakh in aggregate over a lifetime, subject to the prescribed formula. Her ₹18 lakh is within the limit, so it is fully exempt.
- Leave encashment on retirement: exempt under section 10(10AA) up to ₹25 lakh in aggregate over a lifetime for non-government employees. Her ₹6 lakh is within the limit, so it is fully exempt.
Both amounts are therefore tax-free, but the exemptions are lifetime limits. If she had claimed gratuity exemption earlier, the remaining headroom would be lower. She should preserve salary and retirement records because the employer may report these separately in Form 16 and the return.