Real estate is a significant part of an investor?s pie. It is also a time-tested asset, which almost always appreciates, except in times of severe economic downtrends, when it?s temporarily affected. In fact, buying real estate for investment purposes and selling it later at a higher price has become very common among investors. Banks and non-banking financial institutions (NBFCs) have also helped in this trend by providing easy loans to investors. What is confusing for many investors, though, is the tax structure on these real estate transactions. Here, we explore the tax liability on such transactions, also known as capital gain (or loss).
Capital Gain Tax Structure
Income-tax rules classify gain into two broad categories: short-term capital gain (STCG) and long-term capital gain (LTCG). If an investor buys and sells assets within three years, this comes under short-term capital gain. If an investor buys real estate, keeps it for more than three years and, then, sells it, it comes under long-term capital gain. For short-term capital gain, the gain from the asset is added to the investor?s income and taxed as per the income slab he falls under. For example, if an investor falls under the tax slab of 30%, the gain will also be taxed at 30%.
For long-term capital gain, the tax calculation involves what is known as indexation. The acquisition cost or cost of acquiring the asset is recalculated based on indexation. Indexation is a concept that factors in inflation in its calculation by using cost-inflation index (CII). The cost-inflation index number is published every year by the Reserve Bank of India (RBI) and one can use it to find out the taxable gain on a transaction.
Indexation
Suppose you bought 2 acre of land today at R5 lakh per acre. This means your purchase price is R10 lakh. After five years, the price goes up to R7 lakh per acre. If you sell at the end of five years, you will receive R14 lakh. The holding period return will be 40% or R4 lakh (R14 lakh?R10 lakh). The question is should you pay taxes on the returns of R4 lakh? The answer is no.
The price of property will not be considered as R10 lakh while calculating the gain. It will be taken as more than R10 lakh by using CII. Hence, the investor will have to pay taxes on an amount less than R4 lakh. Let?s see an example.
Rahul bought 10 acre of land at R3 lakh per acre on January30, 2000. He paid R30 lakh for the property.
Case 1: He sold the property on April 30, 2002, at R4 lakh per acre. This means he sold it at R40 lakh and before three years. Hence, short-term capital gains will be applicable. In this case, there will be no indexation benefit and Rahul will have to pay tax
on the gain, which is R10 lakh (R40 lakh ?R30 lakh). The gain of R10 lakh will be added to his regular income and will be taxed as per the tax slab
he falls in.
Case 2: He sold the property on January 10, 2004, at R4.2 lakh per acre. This means he received R42 lakh. Moreover, since this is done after three years, the gain will be taxed by factoring indexation. Hence, the investor will not pay tax on R12 lakh (R42 lakh?R30 lakh), but an amount less than 12 lakh.
In this case, let?s take a look at the CII numbers (see table). Numbers for other years which are not relevant to us have been skipped. Now, to calculate long-term capital gain, the acquisition price will not be taken as R30 lakh; a new figure will be considered. This is also known as indexed cost of acquisition, which factors in CII.
The new price of acquisition = Initial price x (CII for the year sold / CII for the year bought)
This will give R30 lakh x (463/389) = R35.71 lakh.
The capital gain will be R42 lakh ?R35.71 lakh = R6.29 lakh. This is the amount on which the investor has to pay taxes at 20%. This means the investor will have to pay an amount of 20% of R6.29 lakh = R1.25 lakh.
Note: Investors can deduct any other cost spent on the improvement of the property. This will take tax liability further down. You can also calculate indexed cost of improvement to take it further down.
