Summary: Capital gain bonds provide tax exemption on capital gains for selling a land or building, or both, by reinvesting long-term profits into government-backed securities. By locking in funds for five years, investors gain a stable, low-risk instrument that shields property sale proceeds from immediate capital gains tax.
Quick Overview
- Capital gain bonds allow property sellers to legally avoid long-term capital gains (categorized under Section 85 after April 2026)
- Within six months of selling a property, you can invest the profit in these bonds to get tax exemption on the profit, up to ₹50 lakh.
- Capital gain bonds have a five-year lock-in period without an early exit and may pay an annual interest rate of around 5.25%
- Only government-backed institutions can issue capital gain bonds, and they are backed by government-owned entities and generally considered low-risk
- The investment limit is ₹50 lakh per year, with a minimum investment of ₹10,000 for one bond.
Selling a property after years of holding it can create a sizable long-term capital gains (LTCG) tax bill. But what if there was a legal way to claim exemption on those gains while keeping your money invested in a relatively stable instrument?
Capital gain bonds let you do exactly that. By reinvesting eligible gains into government-backed bonds within a fixed timeline, you can claim tax exemption under Section 85 and potentially save taxes.
In this blog, we break down how capital gain bonds work, who can invest, how the tax benefit applies, and the key things to know before making a decision.
What are Capital Gain Bonds under Section 85?
Capital gain bonds are different from traditional bonds because they are specifically designed to help investors like you save tax on long-term capital gains arising from property sales. These bonds allow eligible investors to claim tax exemption under Section 85 in 2026. Previously classified as 54EC bonds, these instruments are now reclassified as Section 85 capital gains tax exemption bonds from April 2026 onwards, with no major changes to their underlying regulations.
Generally, when you sell a property after holding it for more than 24 months, the profit earned is taxed as long-term capital gains. However, instead of paying tax on the entire gain immediately, you can reinvest the eligible capital gains into these bonds within 6 months of property sale. The invested amount then qualifies for tax exemption under Section 85.
However, not every investor or asset sale qualifies for this benefit. There are specific eligibility conditions that must be met to invest in capital gain bonds and claim an exemption on long-term capital gains.
Eligibility Criteria For Capital Gain Bonds
You must meet the following conditions in order to claim exemption under Section 85:
- The capital gains should arise from the sale of immovable property such as land, a building, or both
- The property must be held for more than 24 months before sale
- The exemption is available to individuals, HUFs, companies, and LLPs
- Gains from shares, mutual funds, gold, or other movable assets do not qualify
- The investment must be made within 6 months of the property sale date
- The investment should be made only in the notified Section 85 bonds
- The maximum investment eligible for exemption is ₹50 lakhs across the current and subsequent financial year combined
- The bonds cannot be sold, transferred, pledged, or used as collateral for 5 years from the date of investment
- Violating the lock-in conditions can lead to the withdrawal of the tax exemption claimed
While eligibility determines who can invest and claim the exemption, understanding the core features of capital gain bonds is equally important to evaluate whether they fit your liquidity needs, return expectations, and overall financial goals.
Key Features of Section 85 Capital Gain Tax Exemption Bonds
Capital gain bonds are designed only for capital gains reinvestment. Issuers typically require you to provide proof of capital gains and details of the property sale. The key features of capital gain bonds are the following:
Investment Limits
The minimum investment required to purchase one unit of a capital gain bond is ₹10,000, while many platforms set a minimum of 2 bonds, requiring a minimum investment of ₹20,000. Whereas, the maximum investment eligible for tax exemption is ₹50 lakhs per financial year. This cap applies even if the six-month window spans across two financial years for a single property sale.
Lock-in Period
Capital gain bonds have a 5-year lock-in period. During this time, you cannot sell, transfer, or pledge the bonds. If you attempt to exit early or take a loan against them, the tax exemption may be revoked. This makes liquidity a key consideration before investing.
Interest Rate
Capital gain bonds offer modest returns of around 5.25% per annum, depending on the issuer and issue period. The interest rates of these bonds are generally similar to government bond yields. However, the tax benefit from capital gain bonds reduces the need for higher returns.
Typically, the coupon payout in capital gain bonds happens only once a year and remains consistent across most issue years.
Taxation on Returns
The primary reason investors invest in capital gain bonds is to claim tax exemption on the capital gains from properties. This tax benefit applies only to the principal invested. The interest earned through these bonds does not qualify for exemption. The annual interest income gets added to your taxable income and is taxed based on your slab rate, even though no TDS is deducted.
Over the last few years, capital gain bonds have also seen a few important regulatory and issuer-related developments that you should be aware of before investing.
Latest Updates on Capital Gain Bonds (2025-2026)
Some recent updates have expanded how capital gain bonds work and where your money flows.
Housing and Urban Development Corporation Limited (HUDCO) bonds were officially included as issuers of capital gain bonds in April 2025, with funds directed to urban development and housing initiatives. In July 2025, the government notified that these bonds can be issued by the Indian Renewable Energy Development Agency (IREDA). These bonds direct funds into renewable energy projects.
Another important update is that, effective April 1, 2026, the relevant provision for capital gain bonds has transitioned from Section 54EC of the 1961 Act to Section 85 of the Income Tax Act, 2025. The basic structure, such as the five-year lock-in period and fixed returns, etc. was not changed; however, this new addition provides sector exposure, enabling you to invest in debt instruments in the energy and urban infrastructure sectors.
How Section 85 Helps You Save Tax
Section 85 allows you to reduce your long-term capital gains (LTCG) tax liability by reinvesting eligible gains into specified capital gain bonds.
Currently, long-term capital gains from property sales attract a 12.5% tax without indexation. Instead of paying tax on the entire gain upfront, you can reinvest a portion of the gains into notified bonds and claim an exemption on the invested amount. Let us understand with an example. Suppose you earn a long-term capital gain of ₹80 lakhs from selling a property.
Under Section 85, you can invest a maximum of ₹50 lakhs in notified capital gain bonds to claim exemption. The investment must be made within six months of the property sale, and the bonds come with a five-year lock-in period.
Here is how the tax calculation works:
- Total LTCG from property sale: ₹80,00,000
- Amount invested in capital gain bonds: ₹50,00,000
- Exempt LTCG portion: ₹50,00,000
- Remaining taxable LTCG: ₹30,00,000
At a 12.5% LTCG tax rate:
- Tax payable on ₹30 lakhs = ₹3,75,000
So, your final LTCG tax liability becomes ₹3,75,000.
Now assume that the capital gain bond is offering a 5.25% annual coupon rate.
- Total interest earned over 5 years on ₹50 lakhs = ₹13,12,500
- Principal amount returned at maturity = ₹50,00,000
Without investing in capital gain bonds, the entire ₹80 lakhs gain would have been taxable.
- Tax payable on ₹80 lakhs at 12.5% = ₹10,00,000
This means investing ₹50 lakhs in capital gain bonds helps reduce your tax liability by ₹6,25,000.
In addition to the tax savings, you also earn ₹13,12,500 as interest income over five years. However, the interest earned on these bonds remains taxable as per your applicable income tax slab.
List of Capital Gain Bonds in India
Not all types of issuers can issue capital gain bonds. Only public sector entities, authorized by the government, can issue capital gain bonds under Section 85. These institutions use the funds from investors to support large-scale infrastructure and development.
The current list of eligible issuers is:
- Rural Electrification Corporation (REC)
- Power Finance Corporation (PFC)
- Indian Railway Finance Corporation (IRFC)
- National Highways Authority of India (NHAI)
- Housing and Urban Development Corporation (HUDCO)
- Indian Renewable Energy Development Agency (IREDA)
The availability of capital gain bonds also varies based on the issuers. Some issuers may pause or limit subscriptions based on funding needs. The availability of capital gain bonds at the time you earn profits from selling your property affects your options.
Step-by-Step Process to Invest in Capital Gain Bonds
The process of investing in capital gain bonds differs from regular bond investments. Each step must be completed with accuracy and within the timeline.
- Confirm your capital gains: Calculate the long-term capital gains from your property sale. Only gains from land or buildings qualify under Section 85.
- Track the six-month deadline: You must invest within 6 months of the sale date. This window is strict and non-negotiable.
- Choose an eligible issuer: Look for capital gain bonds issued by authorized issuers currently open for subscription.
- Complete the application: Fill out the application form on their website online or at the designated bank branches offline. Ensure that you provide PAN, address proof, and sale-related documents as required by the issuer.
- Select the holding format and make the payment: Choose between demat or physical form. Pay via bank transfer, check, or digital bonds as allowed by the issuer.
- Receive the bond allotment: After verification, the issuer allocates bonds and credits interest annually. The bond matures at the end of the five-year lock-in period; at that time, it is automatically redeemed, with no option to extend the tenure or stay invested for a longer duration.
While capital gains tax exemption bonds require direct issuer applications, Online Bond Platform Providers (OBPPs) like Jiraaf offer convenient access to investment-grade corporate bonds with 8-14% yields. These bonds may offer relatively higher yield potential across fixed-return instruments rated between AAA and BBB, depending on the issuer, credit profile, and prevailing market conditions.
Conclusion
Capital gain bonds are not designed to maximize returns. They are designed to solve a very specific problem: reducing LTCG tax after a property sale. If you are comfortable locking in a portion of your gains for five years, these bonds can offer meaningful tax savings while keeping capital in relatively stable, government-backed instruments. The key to investing in these bonds is timing the investment correctly, understanding the lock-in conditions, and evaluating whether the tax benefit outweighs the trade-off in liquidity and returns.
