If you plan to sell an old property and utilize indexation benefits for calculating capital gains, be careful, as this benefit is not applicable in all situations due to the ‘grandfathering provision’ introduced by the government.
Properties acquired on or before July 22, 2024 and sold on or after July 23, 2024 are eligible for a special option only if the seller is a resident individual or resident Hindu Undivided Family (HUF). Eligible taxpayers can calculate their LTCG tax under both methods, i.e. 20% with indexation, or 12.5% without indexation.
This grandfathering provision is not available to non-resident individuals, companies, firms, LLPs or other categories of taxpayers. It also does not apply to properties acquired on or after 23 July 2024, for which long-term capital gains are generally taxable at 12.5% without indexation.
How does the indexation benefit work?
The indexation benefit is a mechanism that adjusts the purchase cost of a capital asset for inflation using the Cost Inflation Index (CII) notified by the Income Tax Department.
The objective is to ensure that taxpayers are taxed only on the real gain arising from an asset and not on the portion of the gain attributable to inflation over the holding period.
Under the old capital gains rule, the indexed cost of acquisition and improvement was deducted from the sale consideration to arrive at taxable long-term capital gains
The indexed cost is calculated using the following formula:
Indexed Cost of Acquisition = Original Cost × (CII of Year of Sale ÷ CII of Year of Purchase)
By increasing the acquisition cost to reflect inflation, indexation reduces the taxable capital gain and, accordingly, the tax liability.
This benefit remains available under the grandfathering provisions for eligible resident individuals and HUFs selling immovable property acquired on or before 22 July 2024.
How does the choice between the two tax methods affect exemptions under Sections 54, 54EC, and 54F?
The choice between the two long-term capital gains tax methods, namely 20% with indexation and 12.5% without indexation, does not alter a taxpayer’s eligibility to claim exemptions under Sections 54, 54EC and 54F of the Income-tax Act.
“These exemptions continue to be available subject to the fulfilment of the respective conditions relating to reinvestment in residential property or specified bonds. However, the choice of tax computation method can have an indirect impact on the quantum of exemption and the overall tax outcome,” said CA (Dr.) Suresh Surana.
Under Section 54, the exemption is available where capital gains from a residential house are reinvested in another residential house.
Under Section 54EC, capital gains arising from land or a building may be invested in specified bonds within six months, subject to the overall limit of Rs. 50 lakh.
Under Section 54F, full exemption generally requires investment of the entire net sale consideration in a residential house; otherwise, the exemption is proportionate. However, Section 54F exemption can only be claimed where the long-term capital gains do not arise from a residential house property.
Also, Indexation does not alter the net sale consideration and therefore does not change the proportion invested for Section 54F, although it may change the underlying capital-gain amount.
“Taxpayers should not evaluate the two tax regimes in isolation. The optimal approach is to compute the capital gains under both methods, factor in the available exemptions under Sections 54, 54EC or 54F, and then determine which combination results in the lowest overall tax liability,” said Surana.
In many cases, the interaction between indexation and exemption provisions can significantly influence the final tax outcome.
How should taxpayers decide whether to opt for indexation or the lower tax rate without indexation?
Eligible taxpayers should calculate their final tax liability under both methods and select the lower amount.
“The comparison should be made after considering transfer expenses, eligible capital-loss set-offs, exemptions under Sections 54, 54EC or 54F, the available basic exemption limit, surcharge and health and education cess. Taxpayers should not select a method merely by comparing the headline rates, as the 20% indexed method may produce a significantly lower taxable gain,” stated Surana.
“Generally, indexation may be more beneficial where the property has been held for a long period, and its value has increased largely because of inflation. On the other hand, the 12.5% rate without indexation may be preferable where the holding period is comparatively short, or the property has appreciated substantially beyond inflation,” Surana further commented.
Accordingly, taxpayers should prepare a side-by-side computation of the final tax payable under both methods and retain the purchase documents, improvement-cost evidence and Cost Inflation Index working supporting the selected computation, Surana further recommended.
How to file ITR?
Taxpayers who earn capital gains from the sale of immovable property are required to report such income under the head “Capital Gains” while filing their Income Tax Return (ITR).
The choice of ITR form depends on the taxpayer’s overall income profile and the nature of income earned during the financial year.
For most individuals and HUFs who have capital gains from the sale of property and do not have any income from business or profession, ITR-2 would be the appropriate return form. However, where the taxpayer also has income from business or profession, the gains would generally need to be reported in ITR-3.
The capital gains transaction should be disclosed in Schedule CG (Capital Gains) of the applicable ITR. Taxpayers are required to furnish details such as the date of acquisition, date of transfer, sale consideration, cost of acquisition, cost of improvement, transfer-related expenses, indexation details (where applicable), and any exemptions claimed under Sections 54, 54EC or 54F.
From a documentation perspective, taxpayers should ensure that they maintain adequate records to substantiate the computation of capital gains and any exemptions claimed. This typically includes:
- Purchase deed/allotment letter
- Sale deed
- Stamp duty valuation details, where applicable
- Proof of cost of improvement or renovations
- Brokerage and other transfer expense documents
- PAN details of the buyer, wherever required
- Proof of investments made for claiming exemptions under Sections 54, 54EC or 54F
- Form 26AS, AIS/TIS, Form 16 (if applicable) and tax payment challans for reconciliation purposes
Taxpayers should first determine the correct return form based on their income profile, report the transaction under Schedule CG, and ensure that all relevant supporting documents are available to support the capital gains computation and exemption claims, if any.
Disclaimer: This article is for informational purposes only and does not constitute professional tax advice. Tax laws and regimes are subject to frequent changes by the government. Readers should verify details with official Income Tax Department notifications or consult a Chartered Accountant before making any financial decisions.
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