Taxation of Inherited or house received as gift

Balwant Jain

There is widespread confusion about taxation surrounding an inherited property. In this article I intend to cover this.

Taxation on annual basis

Every person who owns a property is taxed under the head “Income from House property” on annual basis. The basis of taxation is annual value of the property which in turn is derived from the rent received or reasonable rent for which the property is expected to be let. In respect of the only one self occupied house property, the annual value is taken as nil. For let out property the value of annual rent received is taken as “annual value” generally.

A standard deduction @ 30% of the annual value/rent received is allowed in respect of let out property or additional self occupied properties where notional rent is offered for tax. Since the annual value of one self-occupied house property is nil, no deduction is effectively available in respect of repairs.

In addition to the deduction for repairs you are entitled to deduction for interest paid to purchase so in case you have inherited the property without any outstanding loans, you will not get any deduction for interest. However in case any money is borrowed by you for repairs, renovation etc of the inherited property, you will be entitled to get deduction of upto Rs. 2 lacs in case such such loan is taken after 1^st April 1999.

Taxation on sale of the property

People at large believe that money received on sale of an inherited house is fully tax exempt. This is not correct. Yes any asset received as inheritance is fully exempt from gift tax but amount on sale of such asset is not exempt from tax. It will be taxable under the head capital gains.

The capital gains either may be short term or long term depending on the period for which the asset was held. In case the inherited house is held for more than 36 months it is long term.

While calculating the holding period of the house inherited by you, the period for which the it was held by the previous owner is also be added to your holding period.

Long term capital gains are calculated by deducting the cost of acquisition of the assets as enhanced by the cost inflation index applicable based on the year of purchase and year of sale. You are also entitled to deduct cost of improvement of the house as indexed with reference to the year of such improvement.

Since you have got the house as inheritance you will think that whole of the money received by you will be taxable in your hand as you have not incurred any cost. The legal position is not so. So for arriving at cost of acquisition, the value to be taken will be the amount any of the previous owner has paid for it. For example in case you inherited the house from your father and he had inherited the same from his father. Your grandfather had purchased it for a Rs. 50,000/-. So the amount paid by your grand father shall be considered as the cost of acquisition capital gains purposes. However in case the asset was inherited by you before 1^st April 1981, you have the option to substitute the fair market value of the property as on 1^st April 1981 for the cost of acquisition. So in case the asset is inherited by you after 1^st April 1981 though you will have to take Rs. 50,000 as cost of acquisition but apply the indexation with reference to the year in which you inherited it as per the strict legal reading of the provisions of law. However there are various decisions of few high courts including Mumbai, Delhi and Gurjat where the courts have held that in respect of inherited property tax payer will not only be entitled to substitute the cost paid by any of the previous owners in case the asset is acquired after 1^st April 1981 but also the tax payer shall be entitled to get the benefit of indexation from the year in which that previous owner had acquired the house. In any case if the asset was purchased prior to 1^st April 1981, you still have the option to substitute market value as on 1^st April 1981 but also get the indexation benefits from 1^st April 1981 though you might have inherited the same later on.

Exemption from Long term capital gains

So do you have to pay tax on the long term capital gains calculated as above or can you save it? Yes you can save the taxes. What you have to do is either buy one house within two years from date of sale of the inherited house or construct one house within a period of thee years. The amount of money required to be invested in another house is only the indexed long term capital gains as computed above and not whole of the sale value.

You have to utilize the capital gains before the due date of filing of your income tax return, failing which you need to deposit the unutilized portion of the capital gains in capital gains account scheme with an approved bank.

Alternatively or additionally you can buy capital gains bonds of either Rural Electrification Corporation or National Highway authority of India within a period of six months from sale of the inherited house. Please note that the maximum amount of investment you can make is only Rs. 50 lacs for saving capital gains tax.

From the above it is clear that taxation provisions of inherited property are different than normal property.

(Balwant Jain is a CA, CS and CFP. Presently working as Company Secretary of Bombay Oxygen Corporation Limited. He can be reached at jainbalwant@gmail.com)