Why in news?

The budget 2024 announced the removal of the indexation benefits available on the property sale. Due to this many people who sell their property will now not be able to inflate their purchase price and reduce their capital gains.

What’s in today’s article?

• Capital Gain Tax
• Indexation benefits

Capital Gain Tax

• About
  • A capital gains tax is a tax imposed on the sale of an asset. It is calculated as the difference between the sale price of the property and its purchase price.
  • Any gain or loss incurred from the sale of a house property may be subject to tax under the 'Capital Gains' head.
  • Similarly, capital gains or losses may arise from sale of different types of capital assets such as stocks, mutual funds, bonds and other investments.
• Types
  • Depending of the period an asset is held with the owner, there are two types of capital gains - Short-term Capital Gains and Long-term Capital Gains.
• Budget 2024 and Capital Gain Tax
  • For classifying assets into long-term and short-term, there will only be two holding periods: 12 months and 24 months.
    • The holding period has been removed.
  • All listed securities with a holding period exceeding 12 months are considered Long-Term. The holding period for all other assets is 24 months.
  • The taxation of Short-Term Capital Gain for listed equity shares, a unit of an equity-oriented fund, and a unit of a business trust has been increased to 20% from 15%.
    • Other financial and non-financial assets which are held for short term shall continue to attract the tax at slab rates.
  • The limit on the exemption of Long-Term Capital Gains on the transfer of equity shares or equity-oriented units or units of Business Trust has increased from Rs.1 Lakh to Rs.1.25 lakh per year.
    • However, the rate at which it is taxed has increased from 10% to 12.5%.
  • The tax on long-term capital gains on other financial and non-financial assets is reduced from 20% to 12.5%.
• Indexation benefits removed in Budget 2024
  • The indexation benefit that was previously available on sale of long-term assets, has now been done away with.
  • So, any sale of long-term asset made after 23rd July, 2024, will attract tax rate of 12.5% only without indexation benefit.
    • The indexation benefit, however, can be taken on the sale of property bought or inherited before 2001.

Indexation benefits

• About
  • In case of property sale, indexation helps in adjusting its purchase price according to the prevailing inflation rate.
  • So basically, the adjustment inflates the purchase price of a property considering the inflation over the invested years.
  • This ultimately brings down the taxable capital gains on the sale of the property.
  • Through indexation, investors can accurately determine their capital gains and be assured that they are paying taxes only on the real gains after inflation is adjusted.
• Calculation
  • The government releases cost inflation index (CII) numbers to index capital gains on specified assets.
    • CII number takes into account the prevailing inflation for the particular financial year.
  • Formula to calculate the adjusted purchase price using the cost inflation index is:
    • Indexed cost = Purchase Amount * (CII in year of sale / CII in year of purchase).
    • Initially, I-T department had set 1981 as the base year and later shifted it to 2001, with a base value of 100.
    • Each year’s index is computed relative to this base.
  • This adjustment ensures that the taxable gain reflects the real increase in the asset’s value, not just the effect of inflation.
• Example (under the previous tax rules)
  • Purchase Price of Property: ₹50 lakh
  • Adjusted Purchase Price (Indexed): ₹64.82 lakh
  • Sale Price (2024-25): ₹70 lakh
  • Long-Term Capital Gain (LTCG): ₹5.18 lakh
  • LTCG Tax Liability: ₹1.036 lakh (20% of Gain)
• Example (under new tax rule – Budget 2024)
  • Purchase Price of Property: ₹50 lakh
  • Sale Price (2024-25): ₹70 lakh
  • Gain: ₹20 lakh
  • LTCG Tax Liability: ₹2.5 lakh (12.5% of Gain)
• Possible impact of removal of indexation benefit
  • Slowdown in the resale market
    • It may discourage owners of older residential properties and land from selling, as the increased tax liability reduces their potential profit.
  • Rise in cash transactions
    • There’s a concern that this change could incentivize under-the-table cash deals to avoid the higher tax burden, counteracting efforts to formalize the real estate sector.
  • Higher property prices
    • Sellers may attempt to offset the increased tax burden by raising property prices, effectively transferring the cost to buyers.