Section 85: capital gains exemption on investment in specified bonds

Introduction

Long-term capital gain on land or building can be sheltered by investing in a specified bond within six months. The investment cap, five-year holding condition and bar on a duplicate Section 123 deduction all affect the final claim.

Key takeaways

What Section 85 says

Where an assessee has long-term capital gains from transferring land or building (or both) - the "original asset" - and within six months of that transfer invests all or part of the gains in a "long-term specified asset" (the "new asset"), the gains are treated as follows: if the gains exceed the amount invested, only the excess is charged to tax under Section 67; if the gains are equal to or less than the amount invested, none of the gains are charged to tax.

The ₹50 lakh investment cap

The amount that can be invested in the long-term specified asset out of capital gains from one or more original assets cannot exceed ₹50 lakh - whether counted during any single tax year, or across the year of transfer and the following tax year taken together.

Five-year lock-in and what breaks it

If the new asset (the bond) is transferred, or converted into money in any other way, within five years of acquisition, the capital gains that were earlier not charged to tax become chargeable as long-term capital gains in the tax year of that transfer or conversion.

Taking a loan or advance against the security of the new asset is itself treated as converting the new asset into money, on the date the loan or advance is taken - so pledging the bond as collateral triggers the same consequence as selling it.

No double benefit with Section 123

If the investment in the new asset has already been taken into account for the Section 85 exemption, no deduction can also be claimed for the same investment under Section 123 (the combined ₹1,50,000 deduction section) for any tax year.

What counts as a "long-term specified asset"

• A bond redeemable after five years, issued on or after 1 April 2018, by the National Highways Authority of India
• A similar bond issued by the Rural Electrification Corporation Limited
• Any other bond notified by the Central Government for this purpose

Step-by-step flow for applying Section 85

1. 1

   Are there long-term capital gains from transfer of land or building, or both?

   • No: Section 85 does not apply.
   • Yes: Go to the next step.
2. 2

   Was the gain invested within six months in a long-term specified asset?

   A bond redeemable after five years, issued on or after 1 April 2018 by NHAI or Rural Electrification Corporation Limited, or another notified bond.

3. 3

   Apply the ₹50 lakh ceiling

   Investment counted from gains on one or more original assets cannot exceed fifty lakh rupees in any tax year, or across the year of transfer and the next tax year.

4. 4

   Compare the gain with the eligible investment

   • Gain exceeds investment: Only the excess is charged under Section 67.
   • Gain equal to or less than investment: Nothing is charged.
5. 5

   Watch the five-year lock-in

   Transfer, conversion into money, or a loan or advance against the bond within five years makes the relieved gain long-term capital gains of that year. No Section 123 deduction for the same investment.

Practical checklist

Glossary

Long-term specified asset

A bond meeting the issuer, issue-date and redemption requirements in subsection (6).

Deemed conversion

The rule treating a loan or advance secured on the bond as conversion into money.

Frequently asked questions