Now you will have to pay more tax on property sale, Indexation Benefits removed by Govt

The government has announced a major update to the tax treatment of real estate. Indexation benefits, which adjust property values for inflation, will no longer apply to properties purchased after 2001. However, this benefit will still be available for properties bought before 2001. Alongside this change, the long-term capital gains (LTCG) tax on real estate will be reduced from 20% to 12.5%, with the goal of simplifying tax calculations.

What is Indexation?

Indexation is a method used to adjust the purchase price of an asset, such as property, to account for inflation over time. This adjustment helps in accurately determining the capital gains or profit made from selling the asset.

How Does Indexation Work?

To calculate the inflation-adjusted purchase price, you use the Cost Inflation Index (CII) published annually by the government. Here’s how it works:

1. Find the CII for the Year of Purchase: This is the index number for the year you bought the property.
2. Find the CII for the Year of Sale: This is the index number for the year you are selling the property.
3. Adjust the Purchase Price: Multiply the original purchase price by the CII of the sale year and divide by the CII of the purchase year. This gives you the adjusted purchase price reflecting inflation.

Recent Changes to Taxation Rules

Previously, property sellers in India could benefit from indexation to reduce their tax liability. However, recent changes have removed this benefit for properties purchased from 2001 onwards.

New Tax Rules

1. Long-Term Capital Gains (LTCG) Tax: Properties purchased in or after 2001 will now be subject to a 12.5% LTCG tax upon sale.
2. Removal of Indexation: The benefit of adjusting the property’s purchase price for inflation has been eliminated. This means that sellers can no longer adjust their purchase price to reflect current market conditions.

Impact of the Removal of Indexation

• Increased Tax Burden: Without indexation, the taxable capital gain is calculated based on the original purchase price, potentially leading to higher taxes despite the reduced LTCG rate of 12.5%.
• Holding Period Effects: The removal of indexation may result in higher taxes for properties held for shorter periods or with moderate price appreciation. However, for properties held for over 10 years with significant price increases, the impact may be neutral or slightly beneficial.

Example from CLSA

Brokerage firm CLSA provides an example to illustrate the impact:

• Old System: Under the previous rules, the indexed cost of acquisition was calculated using the CII.
• New System: Without indexation, taxes are calculated based on the original purchase price at the reduced rate of 12.5%. For properties held less than 10 years and with modest appreciation, the tax burden is higher under the new system.

Government’s Perspective

The Ministry of Finance has stated that the changes aim to simplify the tax system and benefit the middle class:

• Finance Minister Nirmala Sitharaman: The goal is to streamline taxation, reduce complexity, and encourage investment. The new rate of 12.5% is the lowest in several years, which is intended to make tax calculations more straightforward and less burdensome.

Conclusion

The removal of indexation means that property sellers will face higher taxes unless they reinvest in new properties, which can still offer tax exemptions. While the reduced LTCG rate of 12.5% is lower than before, the lack of indexation adjustment could result in a higher tax burden for many sellers.