Direct and Indirect Taxation · Capital Gains

Section 85 Exemption on Investment in Capital Gain Bonds

Updated 10 October 2026 · Fact-checked

Section 85 of the Income-tax Act, 2025 exempts long-term capital gains on transfer of land or building if you invest the gain in specified bonds (NHAI or REC, or notified) within six months. Investment is capped at ₹50 lakh. The bonds have a five-year lock-in; early transfer or a loan against them makes the exempted gain taxable.

Understand Exemption on Investment in Specified Bonds (Section 85)

Selling land or a building at a profit after a long holding gives a long-term capital gain. Section 85 lets you avoid tax on that gain if you put money into a long-term specified asset instead of keeping it.

The exemption applies only where the original asset is land or building, or both, and the gain is long-term. Shares, gold or machinery do not qualify. You must invest within six months after the date of transfer. Note that the amount you must invest is the capital gain, not the full sale price.

A long-term specified asset is a bond redeemable after five years and issued on or after 1 April 2018 by the National Highways Authority of India or the Rural Electrification Corporation Limited. Any other bond notified by the Central Government also qualifies.

There are two guard-rails. First, investment cannot exceed ₹50 lakh, counted across one or more original assets either in any tax year, or in the year of transfer and the next tax year. Second, the bond has a five-year lock-in. If you transfer it, convert it into money, or take a loan or advance against it within five years, the exempted gain becomes long-term capital gain of that year.

The exemption is proportionate. If you invest less than the gain, only the invested part is exempt and the excess is charged under section 67.

Key rules to remember

Eligible original asset: Long-term capital gain from transfer of land or building, or both; Gain from other assets does not qualify under this section.
Time limit for investment: Within 6 months after the date of transfer; Counted from the date of transfer, not from the date of receiving money.
Gain charged to tax: If gain > investment: taxable = gain − investment (charged under section 67); If gain ≤ investment, the whole gain is not charged.
Exempt amount: Exempt = lower of (capital gain, eligible investment); Eligible investment cannot exceed ₹50 lakh as per the limit.
Investment ceiling: Maximum ₹50,00,000 during any tax year, or in the year of transfer and the next tax year; Applies to investment from gains on one or more original assets.
Lock-in: Transfer or conversion into money within 5 years of acquisition: exempted gain deemed long-term capital gain of that tax year; Taxed in the year of transfer or conversion, not the year of original sale.
Loan on security: Loan or advance on security of the bond = deemed conversion into money on the date of loan or advance; The lock-in is broken even if the bond is not sold.
No double benefit: Investment used for section 85 gets no deduction under section 123; The same amount cannot be claimed twice.

How to solve Exemption on Investment in Specified Bonds (Section 85) questions

Use this order for any question on capital gain bonds.

1Check the original asset: it must be land or building, or both, and the gain must be long-term. If not, section 85 does not apply.
2Compute the long-term capital gain after the usual deductions from sale consideration, cost and indexation or other adjustments as applicable.
3Check the date of investment against the six-month window from the date of transfer.
4Check the bond: NHAI or REC, redeemable after five years, issued on or after 1 April 2018, or a notified bond.
5Apply the ₹50 lakh ceiling to the investment, considering the tax year and the year of transfer plus next year.
6Exempt amount = lower of gain and eligible investment. Taxable balance = gain − exempt amount.
7Test the lock-in: if transferred, converted into money or loan taken within five years, add the exempted gain as long-term capital gain of that later tax year.
8Write a closing line stating the taxable and exempt amounts and the tax year of each.

Quickest way: Four-question check

When to use it: For MCQs and short numericals where time is tight.

Land or building, long-term? If no, stop.
Bond bought within 6 months of transfer? If no, no exemption.
Exempt = lowest of gain, amount invested, ₹50 lakh.
Any sale, conversion or loan within 5 years? If yes, the exempted gain returns as long-term gain in that year.

Common mistakes in Exemption on Investment in Specified Bonds (Section 85)

Investing the full sale price and expecting the full price to be exempt.
Students confuse this with provisions that depend on net consideration.
Fix: Under section 85 the exemption is on the capital gain. Compare the gain with the investment and take the lower.
Applying the exemption to gains on shares, gold or other assets.
The word 'capital gain bonds' sounds general.
Fix: Check that the original asset is land or building, or both, and that the gain is long-term.
Ignoring the ₹50 lakh ceiling.
Students focus on the gain and forget the investment limit.
Fix: Cap eligible investment at ₹50,00,000 for the relevant period before computing the exempt amount.
Counting six months from the date of receiving the money.
Cash flow timing feels more natural than legal timing.
Fix: Count six months from the date of transfer of the original asset.
Taxing the recovered gain in the year of original sale when the bond is sold early.
Students think the earlier return must be revised.
Fix: The exempted gain is deemed long-term capital gain of the tax year in which the bond is transferred or converted into money.
Forgetting that a loan against the bonds breaks the lock-in.
Students assume only a sale counts.
Fix: A loan or advance on the security of the bond is deemed conversion into money on the date of that loan or advance.

Worked examples

Example 1

Mr. Rajesh Iyer sold land in Pune and earned a long-term capital gain of ₹70,00,000. Within four months of the transfer he invested ₹60,00,000 in eligible NHAI bonds (redeemable after five years, issued after 1 April 2018) in the same tax year. Compute the capital gain exempt and chargeable under section 85.

Show the solution

Original asset is land and the gain is long-term, so section 85 can apply.
Investment is within six months and in an eligible bond.
Investment ceiling is ₹50,00,000, so the eligible investment is ₹50,00,000, not ₹60,00,000.
Gain ₹70,00,000 exceeds eligible investment ₹50,00,000.
Exempt = ₹50,00,000.
Chargeable under section 67 = ₹70,00,000 − ₹50,00,000 = ₹20,00,000.

Answer: Exempt ₹50,00,000; long-term capital gain chargeable ₹20,00,000.

Example 2

Ms. Kavita Nair had a long-term capital gain of ₹30,00,000 on sale of a building and invested the whole gain in REC bonds within six months, claiming full exemption. After 3 years she took a loan of ₹10,00,000 against the bonds. How is she taxed?

Show the solution

Gain ₹30,00,000 is not more than the investment ₹30,00,000, and the limit of ₹50,00,000 is not crossed, so the whole gain is exempt in the year of sale.
A loan or advance on the security of the bond is deemed to convert the bond into money on the date of the loan.
The loan is taken within five years of acquisition, so the lock-in is broken.
The capital gain not charged earlier is deemed long-term capital gain of the tax year in which the loan is taken.
The amount deemed is the exempted gain, ₹30,00,000, not the loan amount of ₹10,00,000.

Answer: ₹30,00,000 is chargeable as long-term capital gain in the tax year in which she takes the loan.

Exam tips

Always state the three tests first: land or building, long-term gain, six-month investment. Step marks usually sit here.
In numericals, apply the ₹50 lakh ceiling before comparing with the gain.
For lock-in questions, name the tax year in which the gain becomes taxable. It is the year of transfer, conversion or loan, not the year of sale.
MCQs often hide a trap: a non-land asset, a late investment, or a loan instead of a sale. Read the facts for each.
Mention that no deduction under section 123 is allowed on the same investment if the question touches on deductions.

Practice questions from Capital Gains

Exemption on Investment in Specified Bonds (Section 85) in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Exemption on Investment in Specified Bonds (Section 85): frequently asked questions

Which bonds qualify under section 85?

Bonds redeemable after five years and issued on or after 1 April 2018 by the National Highways Authority of India or the Rural Electrification Corporation Limited qualify. Any other bond notified by the Central Government for this section also qualifies.

What is the maximum investment allowed?

Investment from the gain on one or more original assets cannot exceed ₹50 lakh during any tax year, or in the year of transfer and the subsequent tax year.

What happens if the bond is transferred before five years?

The capital gain that was not charged is deemed to be long-term capital gain of the tax year in which the bond is transferred or converted into money. The same applies if you take a loan or advance on the bond.

Can I claim section 123 deduction on the same investment?

No. Where the investment has been taken into account for section 85, no deduction under section 123 is allowed for that investment in any tax year.