Selling your house? Budget 2024 may have increased your tax burden

Budget 2024 removes indexation benefit for property sales, increasing capital gains tax.

If you own a house, which you plan to sell, it is likely that you will end up paying more tax on the transaction from now own as Budget 2024 announced the removal of indexation benefit available on sale of property. Indexation is a method used to adjust the purchase price of an asset (like property) for inflation over the years. This adjusted price is then used to calculate capital gains, which is the profit made when you sell the asset.  Indexation allows the owner to arrive at the value of the property factoring in inflation.

How does indexation work?

• Purchase price adjustment: The government publishes a Cost Inflation Index (CII) every year, which  is a measure to show how much prices have increased compared to the base year (2001-2002) 
   
• Inflation-adjusted purchase price: When you sell the asset, you multiply the original purchase price by the CII of the year you sold it and divide it by the CII of the year you bought it. This gives you the inflation-adjusted purchase price.

How does this existing system work? 

To determine the current value of an old property, a valuer first establishes its worth as of April 1, 2001. This base value is then multiplied by an index released annually by the Reserve Bank of India to account for inflation, resulting in the property's "fair market value" for any year after 2000.

Previously, long-term capital gains from selling property were taxed at 20%, but you could use indexation to reduce your taxable profit. 

"With the rationalisation of rate to 12.5%, indexation available under second proviso to Section 48 is proposed to be removed for calculation of any long-term capital gains, which is presently available for property, gold and other unlisted assets. This will ease computation of capital gains for the taxpayer and the tax administration," the budget document stated.

The Budget 2024 has introduced two key changes:

• The long-term capital gains tax rate on property has been reduced to 12.5%.
• It has also removed indexation. This is the big change. You can no longer adjust the purchase price for inflation.

If your property was valued at Rs 30,000 many decades ago and is now sold for Rs 1 crore without indexation benefit,  the entire amount arrived at after deducting Rs 30,000 from Rs 1 crore would be considered as capital gains. 

Since you can't adjust the purchase price for inflation, the profit you made on selling the property will appear larger. Even though the tax rate is lower, the higher taxable profit might result in a similar or even higher tax amount compared to the old system. In essence, while the government has reduced the tax rate, the removal of indexation has offset this benefit for many property sellers, leading to a potential increase in their tax liability.

“The Finance Minister's decision to remove the indexation benefit for long-term capital gains (LTCG) tax on real estate marks a significant shift for the sector. While the intention to simplify and rationalise the tax regime is clear, the removal of the indexation benefit, despite the reduction in the LTCG tax rate to 12.5%, could lead to a higher tax burden on real estate transactions,” said Dhruv Agarwala, Group CEO, Housing.com & PropTiger.com.

Old System (with indexation)

• Mr. A bought a property for Rs 25 lakh in FY 2002-2003.
• He sells it in FY 2023-2024 for R. 1 crore.
• To calculate the capital gains, the purchase price of Rs 25 lakh would be adjusted for inflation using the Cost Inflation Index (CII) for the respective years. This adjusted purchase price would then be subtracted from the sale price to determine the taxable capital gain.

New System (without indexation)

• Mr. A still bought the property for Rs 25 lakh in FY 2002-2003 and sold it for Rs 1 crore in FY 2023-2024.
• However, under the new rules, there's no need to adjust the purchase price for inflation.
• The capital gain is simply calculated by subtracting the original purchase price (Rs. 25 lakh) from the sale price (Rs. 1 crore), resulting in a higher taxable capital gain compared to the old system.

Anshul Jain, Chief Executive - India, Cushman & Wakefield, highlighted that while the LTCG rate reduction aligns with the government's focus on tax simplification, the removal of indexation could impact investment demand for residential units in the short term. He remains optimistic about the long-term demand driven by end-users and overall economic growth.

Amit Goyal, Managing Director of India Sotheby's International Realty, said "For real estate transaction, bringing down the long-term capital gains tax from 20% to 12.5% is a welcome step, even if it comes with removal of indexation benefits. This will encourage more liquidity in property transactions. Higher uniformity in long term capital gains tax across different asset classes was a long standing ask of investors."