Impact of Removing Indexation Benefit on LTCG on House Sale

The removal of indexation benefit as Proposed by Union Finance Bill 2024 can seriously impact how much tax you have to pay when you sell a house on your Long Term Capital Gain (LTCG). Here’s how:

Previous tax rate of Long term capital gain for Land or Building = 20% (Indexation benefit available)

New tax rate of long-term capital Gain Tax= 12.5% (No Indexation available)

1. Higher Taxes: Indexation benefit lets you adjust the purchase price of the property for inflation, which lowers the taxable capital gains. Without indexation, you might end up paying taxes on the entire gain from selling the property, resulting in a higher tax bill.
2. Lower Profits: Properties generally go up in value over time, mainly because of inflation. Indexation takes this into account, making sure that only the real gains are taxed. If indexation is removed, even gains due to inflation will be taxed, reducing the profit you make from selling the property.
3. Impact on Long-term Investors: Indexation benefit is especially good for people who hold properties for many years. It lowers the tax rate on capital gains, encouraging long-term investment. Without this benefit, people might not want to invest in real estate for the long term.
4. More Complicated Taxes: Indexation involves using a Cost Inflation Index, so removing it could simplify tax calculations. However, it may lead to higher effective tax rates for property sellers.
5. Economic Effects: Real estate is really important for the economy, and tax policies can change how the market works. Removing indexation could affect investment decisions, property prices, and the overall real estate market.
6. Fairness: Indexation helps in making sure that taxes are fair, especially for people who use property as a long-term investment or for retirement planning. Removing this benefit could be seen as unfair to these individuals.

In short, taking away the indexation benefit when selling a house is likely to mean higher taxes for property sellers, make real estate less attractive for long-term investment, and could have big effects on the real estate market and individual taxpayers.

Let’s illustrate the impact of indexation benefit removal with a numerical example:

Suppose you purchased a house property in April 2000 for Rs. 50 lakhs. You plan to sell it in April 2024 for Rs. 1 crore. Let’s assume the Cost Inflation Index (CII) for the relevant years are as follows:

• Financial Year 2001-02 (purchase year): CII = 100
• Financial Year 2024-25 (sale year): CII = 363

The finance minister in her post-Budget press conference clarified that properties bought before April 1,2001 will have purchase price higher of following:

a) Actual Property Price

b)Fair market value of house as on April 1, 2001,

and if property is bought after April1,2001- Cost of Acquisition will be Actual Purchase Price.

In the illustration we have considered a) as higher-

With Indexation Benefit:

1. Purchase Price Indexed for Inflation: Purchase Price adjusted for inflation = Rs. 50 lakhs × (363/100) = Rs. 18150000
2. Indexed Cost of Acquisition: = Rs. 18150000
3. Capital Gain (Without Indexation): Capital Gains (Without Indexation) = Rs. 1 crore – Rs. 50 lakhs = Rs. 50 lakhs
4. Capital Gains (With Indexation): = Rs. 1 crore – Rs. 18150000 =Rs.8150000

(Rs. 8150000) (This indicates a loss when inflation is factored in)

1. Taxable Capital Gains: Taxable Capital Gains (With Indexation) = Maximum of 0 or (-Rs. 8150000) = 0 (As it is a loss)

Without Indexation Benefit:

1. Capital Gains (Without Indexation): Capital Gains (Without Indexation) = Rs. 1 crore – Rs. 50 lakhs = Rs. 50 lakhs
2. Taxable Capital Gains (Without Indexation): = Rs. 50 lakhs

Tax Calculation:

• With Indexation: Tax payable = 20% of 0 = Rs. 0
• Without Indexation: Tax payable = 12.5% of 50 lakhs = Rs.625000

Impact Analysis:

• Tax Liability Increase: Removing indexation benefit results in a tax liability of Rs. 625000 (without indexation) compared to no tax liability (with indexation).
• Saving in Tax: There would have been saving in tax of Rs. 1630000(20% of Rs.8150000)

The Cost Inflation Index (CII) is a tool used by tax authorities, primarily in India, to adjust the purchase price of an asset for inflation when calculating capital gains tax.

Indexed Cost of Acquisition = (Purchase Price) × (CII of the Year of Sale) / (CII of the Year of Purchase)

Conclusion: The removal or alteration of indexation benefit can potentially increase the tax burden on property sellers, reduce the attractiveness of real estate as a long-term investment, and impact economic dynamics related to property transactions. It underscores the importance of indexation in fair and effective taxation of capital gains on house property sales.

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Disclaimer: The info in this article is based on basic principles of finance and is meant for learning purposes only. It’s not professional advice and shouldn’t be seen as such. Individual financial situations can be different, so it’s best to consult a qualified professional who understands your specific circumstances.