Indexation plays a crucial role in calculating capital gains tax on property, allowing you to adjust the purchase price of an asset according to inflation. This adjustment, guided by the Cost Inflation Index (CII) released by the Income Tax Department each year, significantly reduces the taxable gain amount, thereby lowering your tax liability.
Previously, the indexation benefit was available for non-equity mutual funds (under certain conditions) and physical assets like real estate and gold. However, starting from April 1, 2023, the government removed this benefit for debt mutual funds. In the 2024 budget, it was further announced that indexation would be removed for real estate transactions effective from July 23, 2024.
Given the large investment amounts and the significant appreciation in real estate, this change sparked considerable concern among investors. After much public outcry and numerous representations, the Finance Ministry decided to restore the indexation benefit for real estate, albeit with some conditions.
This article explores what indexation is, how it helps in reducing tax liability, the new rules introduced by the Finance Ministry, the applicable tax rates on long-term capital gains, and the conditions tied to the restored indexation benefit. (Also Read: Budget 2024-25 |10 Important Direct Tax Changes Impacting your Money)
Let me start with defining the capital gain tax on property
- Short-Term Capital Gains Tax on Property: Applies to gains realized within the first 24 months of holding the property.
- Long-Term Capital Gains Tax on Property: Applies to gains realized after holding the property for more than 24 months.
The short-term capital gains will be added in your income, and taxed as per the slab rates. This article is more about Long-term capital gain tax on property
What is Indexation, and How Does it Work?
Indexation is a method used to adjust the purchase price of an asset, such as property, for inflation over time. This adjustment increases the cost price of the asset, referred to as the Indexed Cost of Acquisition (ICoA), and consequently reduces the gain amount at the time of sale. The seller then pays tax at the rate of 20% on this reduced gain. It’s important to note that the indexation benefit was available on long-term capital gains (i.e., for properties held for 24 months or more). (Discover More: How indexation helps in saving Capital gains tax)
Calculation: To calculate the Indexed Cost of Acquisition (ICoA), use the following formula:
ICoA = Original cost of acquisition * (CII of the year of sale / CII of the year of purchase)
The rate of inflation used for indexation is derived from the government’s Cost Inflation Index (CII), which is updated annually on the Income Tax Department’s website.
Changes Introduced in Budget 2024
In the 2024 budget, the government announced the removal of indexation for property sales, fixing the tax rate on long-term gains at 12.5%. Additionally, they removed grandfathering benefit i.e., the indexation benefit for debt mutual funds purchased before April 1, 2023, and subjecting them to a 12.5% tax rate. Please note that for new
Impact of the New Rules: A Hypothetical Example
Let’s consider a hypothetical scenario:
Mr. X bought a flat in Noida for ₹1 crore in FY 2010-11 and sold it on August 1, 2024, for ₹2.25 crore.
- Old Rule (with Indexation):
Indexed Cost of Acquisition = ₹1 crore / 167 * 363 = ₹2.17 crore
Taxable Gain = ₹8 lakh, and the tax liability would be ₹1.60 lakh. (@20%) - New Rule (without Indexation):
Taxable Gain = ₹1.25 crore, and the tax liability would be ₹15.63 lakh. (@12.50%)
The taxation varies based on the growth rate of the property and the purchase date, making it case-specific.
New rules – Capital Gains Tax on property Effective from July 23, 2024
Property owners now have two options to calculate capital gains tax on property sales, allowing them to choose the option with the lower tax liability:
- Option 1: Compute tax on long-term capital gains at 20% after applying the indexation benefit.
- Option 2: Compute tax on long-term capital gains at 12.5% without applying the indexation benefit.
Other Conditions:
- These options are available only to individuals and HUFs for properties bought before July 23, 2024.
- NRIs and non-individuals (e.g., companies, LLPs) are not eligible to choose between these options.
- Long-term capital gains tax on properties (residential or commercial) purchased after July 23, 2024, will be 12.5%.
- If you opt for the indexation benefit, any losses incurred cannot be carried forward or set off against other long-term capital gains.
- Indexation can only be used for tax calculation purposes, not for determining the amount of investment required to claim exemptions.
Conclusion
The recent changes to the capital gains tax rules have introduced new complexities for real estate investors. While the restoration of the indexation benefit provides some relief, it comes with specific conditions that may not be favorable to everyone. It’s essential to carefully evaluate the available options and consider the long-term implications of these tax rules on your investment strategy. Whether you’re planning to sell property soon or in the future, understanding these nuances will help you make informed decisions and optimize your tax liability.
(Also Read: Buying a House: A Practical Approach Amid Uncertainty)
(Explore More: Financial Freedom: A Journey of Responsibility and Minimalism)
NRIs are NOT eleigible to use indexation method. Does it mean that NRIs can claim CAPITAL LOSS if the sale value is less than the BUY value, and adjust the loss against other capital gains??
Yes, as far as my understanding goes, this is allowed. Still, it is advisable to check with CAs who are well connected to this subject.