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1031 US Capital Gains Deferral in India

In the United States, a taxpayer who wishes to avoid paying capital gains taxes upon the sale of property may have the option to defer those gains by entering into a Section 1031 Exchange instead of pursuing a traditional sale of the property.  Although the rules and procedures for a Section 1031 Exchange within the U.S. are complicated, it essentially allows a taxpayer to replace the property sold with another property of “like-kind” within a specific period of time without having to pay capital gains taxes that would otherwise be due on the sale of the original property. Other countries also have similar tax schemes that allow for deferment of capital gains taxes. India is one of those countries.

In India, a taxpayer who sells a residential property is subject to the payment of capital gains taxes just as in the United States. Long term capital gains (assets held for more than three years) in India are taxed at the rate of 20 percent. When the sale is made by a non-resident Indian, or NRI, and the sale is completed with foreign currency, capital gains taxes are computed by “converting the relevant figures of full value of consideration, cost of acquisition etc. into the same foreign currency. The capital gains tax due is also determined in that foreign currency.” Once the amount due is calculated, that figure is then converted to Indian rupees.

Indian Capital Gains Deferral

When a taxpayer wishes to sell a residential property in India, the taxpayer has the option to defer the payment of capital gains taxes by entering into an exchange or transfer instead of a traditional sale. Similar to a Section 1031 Exchange in the United States, India requires the taxpayer to either:

  1. Construct within three years after the sale of the original property, OR
  2. Purchase within one year before or two years after the sale of the original property

In India, the deferral is referred to as a deduction on a taxpayer’s tax return. To take advantage of this option, the taxpayer must first determine how much he or she has already spent in purchasing a new home or in the construction of a new home. Any funds that are earmarked for the purchase or new construction, but which have not yet been spent as of the date the tax return is due, must be deposited into a Capital Gains Deposit Account in a nationalized bank within India. The taxpayer must then provide proof of the investment in new construction or for the purchase of the new property when filing his or her tax return. The funds deposited into the Capital Gains Deposit Account must be used within the appropriate time frame, depending on whether the taxpayer is purchasing or constructing a new home. Any funds remaining in the account after the time frame has passed are subject to capital gains taxation.

A similar deduction/deferral of capital gains taxes is available in India for compulsory acquisition of land and buildings of industrial undertakings. To qualify, the building or land must have been used for industrial undertakings for at least two years prior to the compulsory acquisition. A taxpayer may avoid the payment of capital gains taxes in this situation if he or she purchases land or buildings or constructs buildings within three years after the compulsory acquisition. The requirements relating to a Capital Gains Deposit Account apply in this situation as well.

A US resident with an Indian capital gain can smartly plan their US-India taxes by resorting to like kind exchange regulations contained in IRS Code Section 1031 and the capital gain exemption and deposit scheme offered by Section 54 of the Indian Income Tax Act of 1961.

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