Selling agricultural land remains tax-free. But there is a catch

So, what exactly makes land ‘rural’ in the eyes of the taxman? The answer lies in a set of specific conditions that could mean the difference between zero tax and a hefty capital gains bill.

What is rural agricultural land?

To be considered rural agricultural land, the property must not be located within the limits of a municipal or cantonment board that has a population of 10,000 or more, according to the last census. Remember, the last country-wide census was done only in 2011. The 10-year census that was due in 2021 was suspended due to the covid-19 pandemic.

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If the population of the municipal or cantonment board is more than 10,000 but less than 1 lakh, then the land needs to be 2 km further away from its limits, to qualify as rural agricultural land.

Distance is measured as a straight path, starting from the limits of the municipal or cantonment board. The typical road distance is not considered as roads may not necessarily fall on a straight path and if the road connectivity is poor, land may inadvertently fall within the distance threshold and qualify as rural agricultural land.

If the population of a municipality or cantonment board is more than 1 lakh, but less than 10 lakh, the distance threshold increases to 6 km. The land should be further 6 km away from the limits of the municipal or cantonment board to quality as rural agricultural land.

If the population of a municipality or cantonment board is more than 10 lakh, the land should be further 8 km away from its limits, to quality as rural agricultural land.

Urban land tax guide

If it is an urban agricultural land, capital gains tax is applicable. If the land is sold within two years from ownership, the gains are treated as short-term capital gains (STCG) and are added to the land owners’ income slab rate. If the land is sold after two years, the gains are taxable as long-term capital gains  (LTCG) and are taxed at 12.5%. 

Whether STCG or LTCG, the seller can add expenses related to land acquisition such as brokerage and legal fees to acquisition costs and adjust his net capital gains accordingly. 

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State laws

Not all states allow land to be sold to non-agriculturists, without approval from local authority. For example, in Maharashtra and Gujarat, agricultural land cannot be sold to a non-agriculturist under certain conditions. To do so, you need the consent of a local authority. There is also ceiling on land ownership in each state when it comes to agricultural land.

Definition of agricultural land also varies, as per state laws. 

“Agricultural land (in Maharashtra) is classified as land used for cultivation or sites used by agriculturists for dwelling houses. Besides cultivation of crops, agricultural activities in such land include horticulture, garden produce, grazing cattle, etc,” said Harsh Parikh, partner at Khaitan & Co. 

Government documents also specify the category of land.

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Agricultural or not?

When disputes arise over whether land should be classified as agricultural or non-agricultural, courts rely on a set of key indicators.

“Courts have generally taken the view that it is not merely the land revenue classification as agricultural or non-agricultural that matters, but various other factual aspects need to be taken into account to determine whether the land that is sold is agricultural or not. The matter has to be decided by looking at the cumulative effect of all the facts and not on the basis of any one fact,” said Gautam Nayak, partner at CNK & Associates.

“Some of the factors considered by courts are: the classification of the land in official records, whether the land is assessed to land revenue (tax) or not, whether the land is capable of being used for cultivation, whether the land is actually being used for cultivation by the owner, the intention of the owner in holding the land and the character of the adjoining land—agricultural, residential, commercial or industrial,” he added.