Capital Gain Bonds: Section 85 Rules, Issuers and the 5-Year Lock-In
Capital gain bonds are specialized debt securities issued by government-backed public institutions that allow real estate sellers to exempt their long-term capital gains from income tax. In Indian tax legislation, this statutory relief is governed by Section 85 of the Income-tax Act, 2025, which succeeded Section 54EC of the repealed Income-tax Act, 1961.
When you sell a residential apartment, commercial office, or plot of land at a profit, direct tax statutes provide defined relief avenues. You can reinvest the proceeds into purchasing another residential house, you can pay applicable long-term capital gains tax, or you can allocate the capital gains into notified capital gain bonds. However, these bonds operate under strict statutory constraints. They require an absolute five-year lock-in, enforce an aggregate investment ceiling of ₹50 lakh across tax years, and mandate rigid purchase deadlines from the date of property transfer.
Dhanvantri Capital Services Private Limited, known as Dhanvantree, is an AMFI-registered mutual fund and Specialised Investment Fund distributor, ARN-194216, and a distributor of portfolio management services registered with APMI, APRN10201. We are not registered investment advisers. This page explains statutory direct tax rules, bond issuance frameworks, and compliance timelines for Tax Year 2026-27. It recommends no specific security and sets no course of action. The choice is yours.
The core qualification: only land and buildings qualify
A widespread error among investors is assuming that capital gain bonds can absorb profits from any financial asset. They cannot.
Under Section 85 of the Income-tax Act, 2025, the exemption is available exclusively on long-term capital gains arising from the transfer of land, a building, or both.
The statutory rules establish three clear asset boundaries:
Immovable Property Only: The asset sold must be real estate. You cannot invest capital gains from listed equity shares, mutual funds, gold bullion, or private business stakes into Section 85 bonds to claim an exemption.
Holding Period for Long-Term Status: The land or building transferred must qualify as a long-term capital asset under direct tax statutes. Immovable property generally achieves long-term status when held for more than 24 months from the date of acquisition. If you sell a property held for 24 months or less, the profit is short-term capital gain, and Section 85 cannot be claimed.
Residential and Commercial Properties Both Qualify: Unlike Section 82 (formerly Section 54), which applies strictly to residential houses, Section 85 bonds accept capital gains from any qualifying immovable property. This includes agricultural land situated within specified urban limits, commercial shops, industrial premises, and residential apartments.
To see how real estate transactions are taxed when bonds are not utilized, explore our blog on capital gains tax on property. For an overview of other statutory exemptions, review our central directory on capital gains.
Eligible issuers: who can issue Section 85 bonds?
You cannot purchase ordinary corporate debentures or commercial bank fixed deposits and claim a capital gains tax exemption. The statute restricts eligibility to long-term specified assets issued by notified public entities.
Under Section 85 of the Income-tax Act, 2025, the law specifically identifies bonds issued by:
National Highways Authority of India (NHAI)
REC Limited (formerly Rural Electrification Corporation)
The statute also extends eligibility to any other bonds notified by the Central Government for this purpose. Under active notifications, the central government has also notified qualifying five-year bonds issued by:
Power Finance Corporation (PFC)
Indian Railway Finance Corporation (IRFC)
Housing and Urban Development Corporation Limited (HUDCO), notified via Notification No. 31/2025
Statutory eligibility determines whether a bond qualifies for tax relief, but investors must also check whether a specific issuer currently has an open public tranche accepting subscriptions.
Operational Features Across Active Issue Series
While individual issue terms are governed by each issuer’s respective Information Memorandum, active series (such as REC Series XX) share standard operational parameters:
Face Value and Minimum Subscription: Each bond carries a face value of ₹10,000. Under current information memorandums, the standard minimum subscription is ₹20,000 (two bonds of ₹10,000 each), with applications accepted in multiples of ₹10,000 thereafter.
Coupon Rate: For current open series, the coupon rate is fixed at 5.25 percent per annum. This rate is determined by the issuer’s offering terms and is not an unchangeable statutory rate.
Interest Payout Schedule: Interest is paid strictly on an annual schedule. Payment dates depend on the specific issuer and tranche terms (for instance, REC Series XX mandates annual interest crediting on 30 June). Cumulative compounding is not offered; interest is disbursed annually.
Allotment Format: Bonds can be held in electronic dematerialized (Demat) form through NSDL or CDSL depositories, or in physical certificate format.
Credit Quality: Public tranches issued by these institutions carry top-tier domestic credit ratings (such as CRISIL AAA, ICRA AAA, or CARE AAA), reflecting quasi-sovereign financial standing. However, credit ratings remain opinions of credit risk and should be verified against active rating agency disclosures for each specific bond issue
The rigid six-month deadline and the CGAS reality
The most critical operational compliance requirement under Section 85 is the investment timeline.
Under Section 85(1), the investment in eligible bonds must be completed within a period of six months after the date of transfer of the original property.
Determining the Transfer Date
The six-month statutory clock begins ticking from the legally applicable date of transfer.
In Indian property and tax law, the exact date of transfer depends on the facts of the transaction, applicable property laws, and contractual conditions (such as delivery of possession under registered agreements). Taxpayers should verify the recognized transfer date of their transaction with a qualified legal professional rather than assuming that deed registration dates are universally determinative.
Many sellers mistakenly believe that they can wait until their annual income tax return filing due date to subscribe to bonds. That assumption is incorrect. The statutory requirement demands investment within six months after the transfer occurs, irrespective of the tax return filing calendar.
Why You Cannot Use the Capital Gains Account Scheme
Property sellers frequently ask whether unutilized capital gains can be deposited into the Capital Gains Accounts Scheme, 1988 (CGAS) to purchase bonds at a later date.
The answer under direct tax law is clear:
The Capital Gains Account Scheme is statutorily restricted to exemptions under Section 82 (formerly Section 54) and Section 86 (formerly Section 54F), where the statutory reinvestment window for residential property extends up to two or three years.
CGAS cannot be used to extend the Section 85 bond investment deadline.
If you fail to subscribe and transfer funds to an eligible bond issuer within the statutory six-month period, the capital gain cannot qualify for exemption under Section 85.
To understand how bank deposit schemes operate for residential property reinvestments, read our detailed blog on the capital gains account scheme.
The ₹50 lakh statutory ceiling and the anti-split rule
Section 85 contains a statutory cap designed to limit the maximum deduction a taxpayer can claim against real estate capital gains.
Under Section 85(2), the investment in eligible bonds is restricted by two distinct statutory limits:
The investment made by an assessee in eligible bonds during any tax year cannot exceed fifty lakh rupees.
The total investment made by an assessee from capital gains arising from the transfer of one or more properties during the tax year in which the asset is transferred and in the subsequent tax year cannot exceed fifty lakh rupees.
The Anti-Split-Year Rule Explained
This second restriction prevents taxpayers from doubling their deduction when a property sale occurs late in the tax year.
For example, consider an individual who transfers a commercial building on 15 June 2026 (Tax Year 2026-27), realizing a long-term capital gain of ₹90 lakh:
The maximum aggregate investment permitted in Section 85 bonds for this transfer across Tax Year 2026-27 and Tax Year 2027-28 combined is ₹50 lakh.
The remaining ₹40 lakh of capital gain cannot be shielded using Section 85 bonds.
An investor cannot claim a ₹1 crore deduction by investing ₹50 lakh in March and another ₹50 lakh in April for the same property transfer.
The ₹50 lakh statutory cap applies per taxpayer Permanent Account Number (PAN). Where a property is held jointly by genuine co-owners, each co-owner’s entitlement to invest up to ₹50 lakh depends on establishing their individual legal ownership share, their respective capital gain, and independent funding of the subscription.
How unexempted capital gains are taxed: Section 197 rules
When real estate capital gains exceed the ₹50 lakh statutory bond limit, the remaining uninvested portion remains taxable.
A frequent mistake on personal finance blogs is claiming that all residual property gains are taxed at a flat 12.5%. Under the Income-tax Act, 2025, the tax rate on unexempted long-term real estate gains depends on when the property was acquired and the taxpayer’s legal status:
1. Properties Acquired On or After 23 July 2024
For land or buildings acquired on or after 23 July 2024 and held for more than 24 months, the unexempted capital gain is taxed at a flat rate of 12.5 percent without indexation under Section 197 of the Act.
2. Properties Acquired Before 23 July 2024: The Section 197(3) Ceiling
For properties acquired before 23 July 2024 and transferred by resident individuals or Hindu Undivided Families (HUFs), Section 197(3) establishes a transitional ceiling rule:
Tax is calculated on the unexempted gain at 12.5 percent without indexation.
Tax is also calculated on the gain at 20 percent using the Cost Inflation Index.
The statutory tax payable is capped at the lower of the two calculations.
Returning to our illustrative example of a ₹90 lakh gain with ₹50 lakh invested in bonds, the remaining ₹40 lakh is subject to capital gains assessment. If the property was acquired before 23 July 2024, the taxpayer computes the tax under Section 197(3) to verify whether the 12.5 percent unindexed rate or the 20 percent indexed calculation produces the lower tax liability.
To see historical inflation multipliers for real estate, review our complete schedule of the cost inflation index. For broader rate rules across other asset classes, visit our master directory on long-term capital gains tax.
The 5-year lock-in and the loan-against-security clawback
Older online articles often mention a three-year lock-in period for capital gain bonds. That information is legally obsolete. For all bonds issued on or after 1 April 2018, the statutory lock-in period is strictly five years.
Section 85(3) provides that if the bond is transferred or converted into money within five years from the date of its acquisition, the capital gain originally exempted becomes taxable as long-term capital gains in the tax year in which the transfer or conversion occurs.
| Parameter | Section 85 Capital Gain Bonds |
|---|---|
| Statutory Holding Period | Strictly 5 years (60 months from allotment) |
| Secondary Market Trading | Prohibited; bonds are unlisted and non-transferable |
| Premature Encashment | Not permitted under issuer terms |
| Loan on Security of Bonds | Treated as deemed conversion into money under Section 85(4) |
| Tax Impact of Pledging | Full previously exempted gain becomes taxable in that tax year |
Note: The statutory section reference and tax consequences above are reproduced from the supplied content and have not been independently verified. Confirm the applicable legislation and current bond terms before publication.
The Section 85(4) Deemed Conversion Rule
The primary compliance risk during the five-year holding period involves borrowing. Under Section 85(4), if an assessee takes any loan or advance on the security of the new asset, the bond is deemed to have been converted into money on the date on which such loan or advance is taken.
If you invest ₹50 lakh in eligible bonds to exempt real estate gains, and three years later you pledge those bond certificates as collateral to secure a business overdraft or personal loan, direct tax law treats the action as a deemed conversion.
The entire ₹50 lakh gain previously exempted will be deemed as long-term capital gains taxable in that tax year. Pledging the bond does not cancel the underlying debt contract with the issuer, but it cancels the statutory tax exemption originally granted.
Savers committing funds to Section 85 bonds must ensure they will not need to pledge the securities for liquidity during the 60-month window.
Taxation of bond interest and post-tax yields
While Section 85 bonds exempt capital gains from taxation, the ongoing annual interest earned on the bonds is not tax-free.
The annual coupon earned on capital gain bonds is classified under Income from Other Sources and taxed at your applicable personal income tax slab rate:
Tax Withholding for Resident Bondholders: Under applicable notifications, issuers generally do not deduct Tax Deducted at Source (TDS) on interest paid on these securities to resident individual bondholders. However, the absence of TDS does not make the interest tax-free; bondholders are legally required to report the interest in their annual return and pay tax at their slab rate.
Withholding for Non-Resident Investors: For Non-Resident Indians (NRIs), issuers withhold tax at source on annual interest disbursements in accordance with applicable non-resident tax provisions and Double Taxation Avoidance Agreements.
Illustrative Post-Tax Return
Because the 5.25 percent annual coupon is taxed at regular personal rates, the net yield for taxpayers in higher brackets is modest:
Gross Coupon Rate: 5.25% per annum
Illustrative Marginal Tax Rate: 30% plus 4% health and education cess (effective rate of 31.2%)
Net Illustrative Post-Tax Yield: 5.25% x (1 – 0.312) = 3.61%
Capital gain bonds are primarily a tax-saving instrument rather than a yield-maximization vehicle. The primary economic benefit lies in shielding up to ₹50 lakh of capital gains from immediate direct tax liability.
Section 85 bonds vs residential house reinvestment
When planning property tax exemptions, real estate sellers primarily compare Section 85 bonds against reinvesting in a residential house under Section 82 (formerly Section 54).
The table below contrasts the statutory features of both exemptions for Tax Year 2026-27:
| Dimension | Section 85 (Capital Gain Bonds) | Section 82 (Residential House Reinvestment) |
|---|---|---|
| Eligible Asset Transferred | Land, building, or both held for more than 24 months | Residential house property held for more than 24 months |
| Reinvestment Required | Net capital gain amount | Net capital gain amount |
| Maximum Investment Cap | Strictly ₹50 lakh across the transfer year and the following year | Statutory ceiling of ₹10 crore on the new house |
| Investment Timeline | Strictly within 6 months after the transfer date | Purchase within 2 years, or construct within 3 years |
| Holding Lock-In | 5 years (cannot be transferred or pledged) | 3 years (new property cannot be transferred) |
| Capital Gains Account Scheme | Not permitted; rigid 6-month window | Permitted for unutilized gains before the ITR due date |
| Ongoing Return on Capital | 5.25% annual interest (taxable at slab rates) | Rental income or personal residential use |
Important: This table preserves the supplied information and statutory section references; the legal provisions, eligibility conditions, investment limits, timelines, lock-in rules, and interest rate have not been independently verified. Confirm them against current official tax legislation before publication.
Section 85 bonds offer administrative simplicity. You avoid property registration expenses, stamp duty, developer risk, and tenant management. However, if your long-term capital gains exceed ₹50 lakh, Section 85 cannot shelter the excess balance.
Step-by-step subscription procedure
Applying for Section 85 bonds requires organized execution to ensure that subscription funds are deposited before the six-month statutory deadline expires:
Calculate the Exact Net Gain: Have your chartered accountant compute the exact long-term capital gain realized on the property transfer, accounting for allowable acquisition and transfer expenses.
Confirm Active Issuer Tranches: Review active public offerings from eligible issuers (such as REC, NHAI, PFC, IRFC, or HUDCO) and download the current application form from their official portals.
Assemble Required Documentation:
Self-attested copy of your PAN card.
Valid proof of address (Aadhaar card, passport, or voter identification).
Copy of the transfer deed establishing the transfer date and sale consideration.
Client Master Report (CMR) if subscribing in electronic Demat format.
Cancelled bank cheque showing your name, account number, and IFSC code for electronic annual interest payments.
Submit Application via Authorized Banking Branches: Submit the completed application form along with an account payee cheque or demand draft at authorized receiving bank branches, or complete the process through the issuer’s electronic application portal where available.
Preserve Allotment Proof: Retain the stamped collection acknowledgement and subsequent bond certificate or Demat credit statement. This serves as statutory documentation when claiming the exemption in your annual income tax return.
Common Questions
Under Section 85(2) of the Income-tax Act, 2025, the statutory investment ceiling is ₹50 lakh per assessee across the tax year of property transfer and the subsequent tax year combined.
The statute specifically names NHAI and REC, alongside other public issuers notified by the Central Government, which include PFC, IRFC, and HUDCO (Notification No. 31/2025). Investors should verify active open tranches with the respective issuer.
No. Section 85 applies strictly to long-term capital gains arising from the transfer of land, a building, or both. Profits from listed equities, mutual fund units, gold, or business assets do not qualify.
Under Section 85(4), taking a loan or advance on the security of the bond is deemed a conversion into money. The capital gain originally exempted becomes taxable as long-term capital gains under Section 85(3) in the tax year in which the loan is taken.
No. The Capital Gains Accounts Scheme, 1988 does not apply to Section 85 bonds. Subscriptions must be completed within six months after the date of transfer.
Disclaimer: The views expressed here are of the author and do not reflect those of Dhanvantree. Mutual funds are subject to market risks, please read the scheme documents carefully before investing.