Tax Planning for Property Sellers: Choosing Between 12.5% and 20% LTCG Rates
The government's amendment to the long-term capital gains tax provision on immovable properties gives homeowners a choice between a lower tax rate of 12.5% without indexation or a higher rate of 20% with indexation. Here's a detailed guide to help you dec
LtcgTax PlanningProperty SellersReal EstateInvestmentReal Estate MumbaiAug 08, 2024
This change will allow taxpayers to compute taxes under both schemes and provide them with a choice to pay tax under the scheme in which it is lower. However, the choice between the indexed and non-indexed tax regimes depends on the sale price.
According to tax experts, homeowners should remember that the growth in the value of the property is a crucial factor in deciding which tax rate is more beneficial. If the growth in value is faster, a LTCG tax of 12.5% without indexation may be more beneficial, and where it is slow, the second option may be better.
Indexation benefit may be better for properties that have been held for a longer duration and have witnessed a higher inflation rate. Finance Minister Nirmala Sitharaman had proposed to lower the long-term capital gains tax on real estate to 12.5% from 20% but without the indexation benefit.
Shishir Baijal, Chairman and Managing Director, Knight Frank India, is of the view that while the 12.5% rate may seem immediately attractive, the decision to opt for it or the 20% rate with indexation should be made after careful consideration of individual circumstances.
Ideally, if a property's value has significantly outpaced inflation, the 12.5% rate might be more beneficial. However, indexation could be advantageous in cases where property appreciation is closer to the inflation rate.
To decide which rate is better, homeowners should calculate the taxable gain without indexation by deducting the original purchase price from the sale price. They should also calculate the taxable gain with indexation by deducting the indexed purchase cost, adjusted for inflation using the Cost Inflation Index (CII), from the sale price.
Apply the respective tax rates to the calculated gains 12.5% without indexation and 20% with indexation. Compare the two tax liabilities and opt for the tax rate that yields the lower tax liability.
Additionally, the duration for which the property has been held is a crucial factor while choosing between both the tax regime. For short-term holdings, the benefit of indexation may not be significant enough to outweigh the higher tax rate. In such cases, the non-indexed rate of 12.5% might be more beneficial.
Long-term holdings, on the other hand, can considerably increase the cost basis, which can lead to a lower tax liability even with the higher tax rate of 20%. This makes the indexed rate potentially more favorable for long-term holdings.
In the scenario where a property is purchased and sold within the same year, the resulting gain is classified as short-term capital gain, for which indexation benefits are not applicable. Therefore, the homeowner will incur a tax liability based on the applicable slab rates for short-term capital gains, which do not take inflation into account.
A seller who purchased property in 2010 stands to gain significantly from the indexed regime, as the inflation-adjusted purchase price over a decade lowers the taxable capital gain, allowing them to benefit from the 20% tax rate on a reduced gain.
Individuals planning to sell property inherited in or after July 2024 can still avail the indexation benefits, as the inheritance of property does not constitute a transfer. For the purposes of calculating capital gains, the period of holding and the acquisition cost of the property are considered from the tenure and purchase price of the previous owner.
This means that the beneficiaries can benefit from the reduced taxable gain due to indexation, which adjusts the cost basis for inflation from the time the original owner purchased the property up to the year of sale. Moreover, beneficiaries also have the option to choose the non-indexed regime.
Individuals or Hindu Undivided Families planning to invest in a second property should consider the tax implications under both the indexed and non-indexed regimes. Section 54 of the Income Tax Act, 1961, permits the deduction of costs incurred in acquiring or constructing a new residential property from the capital gains of selling an existing residential house, providing a tax relief that encourages reinvestment.
When opting for the non-indexed regime, it's crucial to remember that indexation benefits are forfeited, potentially leading to higher capital gains and necessitating additional investment in the new property to maximize the Section 54 deduction, with an investment ceiling of ₹10 crore.
Conversely, the Indexed Regime, despite its higher 20% tax rate, allows for an inflation-adjusted cost basis that can lower capital gains. Additionally, this reduction in capital gains not only lowers the tax liability but also means that if the seller is considering reinvesting in a new property, the amount required for reinvestment to claim tax exemption would be correspondingly lower.
For individuals and HUFs considering the transfer of gains from shares to real estate, they still have the options to avail tax benefits on capital gains tax on sale of non-residential assets (including shares) under Section 54F of the Income Tax Act, 1961.
However, if the taxpayer chooses to opt for a non-indexed regime, capital gains on such non-residential assets are likely to be higher, as the acquisition cost won't be adjusted for inflation. This means that to fully utilize the tax deduction under Section 54F, which has an investment limit of ₹10 crore, a larger investment in residential property may be required compared to when indexation was available.
Investors should calculate the tax implications under both regimes and assess whether real estate investment still aligns with their financial goals, considering the increased capital gains and the tax benefits of reinvestment under Section 54F.
The amendment is expected to stimulate investment and sales in the housing market by potentially reducing the tax burden on sellers. However, it's crucial for homeowners to carefully assess their individual circumstances and consider the tax implications before making a decision.
Frequently Asked Questions
How should homeowners choose which tax rate is better for them?
Homeowners should calculate the taxable gain without indexation and with indexation, apply the respective tax rates, and compare the two tax liabilities to opt for the tax rate that yields the lower tax liability.
If a property is bought in 2020 and sold in 2024, what will be the tax liability and which regime should the homeowner opt for?
The tax liability will depend on the sale price. For a property sold at a lower price, the indexed regime may offer a lower tax liability, while for a sale of property at a higher price, the non-indexed regime may be more advantageous.
How will removal of indexation impact property owners wanting to sell their asset after July 2024?
The removal of indexation will lead to higher taxable gains and increased tax liabilities for property owners, as they won't be able to adjust the purchase price for inflation.
If a property is bought and is sold the same year, what will be the homeowner’s tax liability and which regime should he opt for?
The resulting gain is classified as short-term capital gain, for which indexation benefits are not applicable. The homeowner will incur a tax liability based on the applicable slab rates for short-term capital gains.
Will a seller who wants to sell a property acquired in 2020 be impacted more than a seller who bought a property in 2010 or in 2024?
The seller who purchased property in 2010 stands to gain significantly from the indexed regime, as the inflation-adjusted purchase price over a decade lowers the taxable capital gain.
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