The Indian government’s recent budget for 2024-25, presented by Finance Minister Nirmala Sitharaman, has introduced significant changes to the long-term capital gains (LTCG) tax on real estate. These changes include the removal of the indexation benefit and a revision of the tax rate. This article explores the implications of these changes, compares the tax liability under the previous and new rules, and highlights ways to save on taxes under the current regime.
Previously, taxpayers could benefit from indexation, which adjusts the purchase price of the property for inflation, thereby reducing the taxable gain. The removal of this benefit means the taxable gain will now be calculated without adjusting for inflation, potentially increasing the tax liability for sellers. However, the government has also reduced the LTCG tax rate from 20% to 12.5%, which provides some relief. Let’s delve into how these changes impact real estate transactions and what strategies can be employed to mitigate the tax burden.
What is Long-Term Capital Gains Tax?
Long-term capital gains tax is a tax on the profit from the sale of a property held for more than two years. Previously, taxpayers could benefit from indexation, which adjusts the purchase price of the property for inflation, thereby reducing the taxable gain.
Removal of Indexation Benefit
Indexation benefits allowed taxpayers to adjust the purchase price of the property according to the inflation rate. This adjustment often significantly reduced the taxable capital gain. The government’s decision to remove this benefit means the taxable gain will now be calculated without adjusting for inflation, potentially increasing the tax liability for sellers.
Comparing Tax Liability: With and Without Indexation
Example Scenario:
- Purchase Price: ₹50,00,000
- Sale Price after 5 Years: ₹1,00,00,000
- Year of Purchase: 2019
- Year of Sale: 2024
Calculations Under the Previous Rule (With Indexation):
- Cost Inflation Index (CII) for 2019-20: 289
- CII for 2023-24: 348
Indexed Cost of Acquisition: Indexed Cost=CII in the Year of Sale / CII in the Year of Purchase × Purchase Price
Indexed Cost=348/289×50,00,000=60,34,602
Taxable Capital Gain: Capital Gain = Sale Price−Indexed Cost = 1,00,00,000−60,34,602=39,65,398
Tax Liability (20% on LTCG): Tax=20% × 39,65,398=7,93,080
Calculations Under the New Rule (Without Indexation):
Taxable Capital Gain: Capital Gain = Sale Price − Purchase Price = 1,00,00,000−50,00,000=50,00,000
Tax Liability (12.5% on LTCG): Tax=12.5%×50,00,000=6,25,000
Comparison:
- With Indexation: ₹7,93,080
- Without Indexation: ₹6,25,000
Despite the removal of the indexation benefit, the reduction in the LTCG tax rate to 12.5% results in a lower tax liability under the new rules, as illustrated by the example above.
Impact of Higher Capital Gains
While the lower tax rate of 12.5% provides relief for modest gains, it can start to pinch as the capital gains increase. For instance, if the sale price were ₹2,00,00,000 instead of ₹1,00,00,000, the taxable gain without indexation would be ₹1,50,00,000, leading to a tax liability of ₹18,75,000 at 12.5%.
Under the previous rules, with indexation, the taxable gain might be significantly lower, and even at the higher tax rate of 20%, the overall tax burden could be less. Therefore, for properties with substantial appreciation, the new tax regime might result in a higher tax outflow, despite the lower rate.
Strategies to Save Tax on Real Estate Gains
Despite the removal of indexation benefits, several sections in the Income Tax Act can help you save on taxes:
- Section 54:
- Purpose: Exemption on LTCG if the capital gains from the sale of a residential property are reinvested in another residential property.
- Conditions: The new property must be purchased within two years or constructed within three years of the sale.
- Section 54EC:
- Purpose: Exemption on LTCG if the capital gains are invested in specified bonds issued by NHAI or REC.
- Conditions: Investment must be made within six months of the sale, and the maximum limit is ₹50 lakh.
- Section 54F:
- Purpose: Exemption on LTCG from the sale of any asset (not just real estate) if the proceeds are invested in a residential property.
- Conditions: The entire sale proceeds must be invested, and the taxpayer should not own more than one residential property other than the new one on the date of sale.
Conclusion
The removal of the indexation benefit for long-term capital gains tax on real estate increases the taxable amount for many property sellers, but the lower tax rate of 12.5% provides some relief. However, as capital gains increase, the 12.5% tax rate can lead to a higher tax outflow compared to the previous regime with indexation benefits. By leveraging sections like 54, 54EC, and 54F, taxpayers can still find ways to reduce their tax liability. It’s crucial to plan your investments and utilize these exemptions effectively to maximize your savings.
For more personalized advice, consider consulting a tax advisor who can provide guidance based on your specific financial situation and investment goals.
