Not all agricultural land sales are tax-free: Check what is taxable and how to report it

Taxpayers often assume that the sale of agricultural land is completely exempt from income tax, though that's not always the case. Whether tax is payable or not depends on factors such as the location of the land and whether it qualifies as a capital assets under the income tax law.

As a result, some agricultural land sales are full tax-free, while others attract capital gains tax. Both taxable and tax-free agricultural land sales are required to be reported while filing income tax return (ITR) but under different heads.

When is an agricultural land sale tax-free?

The sale of only rural agricultural land is exempt from capital gains tax. Under Section 2(14)(iii) of the Income Tax Act, 1961, rural agricultural land is not treated as a capital asset, making it tax-free.

When does a sale of agricultural land becomes taxable?

Any land that is not rural agricultural land will be considered urban agricultural land, making the latter's sale taxable under capital gains.

Under the income tax law, urban agricultural land is considered a capital asset. The tax treatment depends on how long the land was held before it was sold:

• Short term capital gain (STCG): If the land was held for up to 2 years, gains are taxed as per your income tax slab.
• Long term capital gain (LTCG): If held for more than 2 years, gains are taxed at 20% with indexation benefit. The taxpayer (resident individual) also has an option to pay tax at 12.5% without indexation benefit.

What factors determines whether it is a rural or urban agricultural land

The Income-tax Act classifies agricultural land as either rural or urban based on its location and its distance from a municipality.

According to a Cleartax report, a piece of agricultural land is treated as rural agricultural land if:

1. It is situated within the jurisdiction of a municipality and its population is less than 10,000, or
2. It is situated outside the limits of a municipality, then situated at a distance measured:

• More than 2 km from local limits of a municipality or cantonment board having a population of more than 10,000.
• More than 6 km from the local limits of a municipality or cantonment board having a population of more than 1 lakh.
• More than 8 km from the local limits of a municipality or cantonment board having a population of more than 10 lakh.

If the agricultural land does not satisfy these conditions, it is treated as urban agricultural land and taxed accordingly.

How to report sale of urban and rural agricultural land in ITR?

Since rural agricultural Land is not a capital asset, any income arising from such land needs to be disclosed in Schedule EI (Exempt Income) of income tax return in the relevant financial year.

Urban agricultural land, on the other hand, is treated as capital asset, and the sale of such assets needs to be disclosed in Schedule CG (capital gains) in ITR.

How to save taxes on sale of urban agricultural land?

As per Section 54B of the Income-tax Act, the seller of an urban agricultural land can save taxes by reinvesting the sale proceeds. However, they need to fulfill the following conditions:

• The land must have been used for agricultural purposes by the owner or their parents in the two years immediately before the sale.

• The capital gain must be reinvested in purchasing another agricultural land within two years.

If you do not want to reinvest immediately, you can choose to deposit the capital gains in a Capital Gains Account Scheme (CGAS) before the ITR filing deadline.