When calculating capital gains on the sale of an immovable property, one crucial factor to consider is the cost of acquisition,

In February 2023, Saloni Bansal sold her two-bedroom, hall and kitchen apartment in Ghaziabad for Rs 50 lakh. She purchased it in August 2013 for Rs 31 lakh. With the income-tax return filing due date for the last fiscal looming, she is now concerned about calculating her capital gains and determining the tax liability. However, the calculation of capital gains is not as straightforward as it may seem at first glance.

While it may appear that Bansal has made a gain of Rs 19 lakh, the actual calculation of capital gains involves certain considerations and provisions. To fully understand how to calculate capital gains or losses and optimize tax implications, it is important to delve deeper into the process.

THE TERM

When it comes to assessing capital gains or losses from assets, the duration of ownership is an important factor. The tax department categorizes different time periods for various capital assets, including real estate.

Specifically, in the context of residential property, if the cumulative holding period at the time of sale is less than 24 months, the profits derived from the transaction are referred to as short-term capital gains (STCG). On the other hand, if the holding period exceeds 24 months, the gains are classified as long-term capital gains (LTCG)

COST OF ACQUISITION

When calculating capital gains on the sale of immovable property, one crucial factor to consider is the cost of acquisition of the property.

As per income tax regulations, the cost of acquisition of an asset refers to the amount for which the buyer originally acquired the property. This includes expenses of a capital nature incurred in connection with the purchase or completion of the property's title.

For example, when purchasing a property, additional expenses such as stamp duty, registration fees and transfer fees (if applicable) are incurred to legally transfer the property in your name. These expenses are considered part of the cost of acquisition. Other costs such as brokerage fees and legal fees can also be added to the overall cost of acquisition. In the case of purchasing an under-construction property, goods and services tax (GST) is also charged on the purchasing price, and the same can also be included to determine the cost of acquisition.

Besides, it is important to note that expenses incurred for civil work, flooring, plumbing and other essential improvements to make the purchased property habitable can also be considered as part of the cost of acquisition. However, it's crucial to distinguish that expenses related to furniture or optional renovations may not qualify as part of the cost of acquisition.

Furthermore, if you have taken a loan to finance the acquisition of the property, the interest paid on that loan may also be eligible to be included as part of the cost of acquisition, provided you have not already claimed it as a deduction in previous tax filings.

INDEXED COST OF ACQUISITION

Determining the cost of acquisition is just the first step. The next step is to calculate the indexed cost of acquisition to account for inflation. Let me explain: when selling a capital market asset or property, you are liable to pay capital gains tax, which is calculated based on the difference between the sale price and the cost price. Typically, if you hold an asset for a significant period, its value (and thus the sale price) tends to increase. The larger the difference between the sale and cost price, the higher your tax liability.

However, due to inflation, the value of money decreases over time, and it takes more to purchase the same item. In other words, something you bought for Rs 100 several years ago would cost you much more today. In reality, this inflationary price rise is not your actual gain; your gain is the real value appreciation of your capital on which you are required to pay taxes.

To provide relief to taxpayers, the government allows you to factor in the benefit of inflation by calculating the indexed cost of acquisition using the Cost Inflation Index (CII). The government declares the CII number each year, which artificially increases your cost price. This adjustment helps account for inflation and reduces the difference between the sale and cost prices. Consequently, this adjustment lowers your tax liability, specifically the capital gains tax.

THE CALCULATION

The indexed cost of acquisition is computed by multiplying the cost of acquisition with the CII value of the year of transfer of the capital asset and dividing by CII of the year of acquisition.

Let’s take Bansal’s example. She bought the house in 2013-14 for Rs 31 lakh and sold it for Rs 50 lakh in 2022-23. To calculate the indexed costs of acquisition, find out the CII values on www.incometaxindia.gov.in for 2013-14 and 2022-23.

CII is 220 and 331 for the years of purchase and sale, respectively. So, the indexed cost of acquisition would be Rs 51,60,423 [31,00,000 x (220/331)]. Accordingly, her long-term capital loss (LTCL) would be Rs 1,60,423 (50,00,000 - 51,60,423).

So what initially appeared to be significant gains of Rs 19 lakh turns out to be a loss proposition, after adjusting against inflation. Let’s read further to understand what the implications are or options a person has in the case of LTCG or the available options in the case of LTCL as in the case of Bansal.

WHAT IF THERE IS A CAPITAL GAIN?

Gains from real estate transactions, if any, are subject to taxation. STCG from real estate is added to your other income and taxed according to the applicable slab rates. On the other hand, LTCG is taxed at a rate of 20 percent with indexation, excluding surcharge and cess.

Fortunately, there is an option to offset your gains against losses, and vice versa, under certain conditions. This allows you to minimize the tax implications and optimize your overall tax liability. “Long-term gains can only be set off against long-term losses and short-term capital gains can be set off against long-term or short-term losses. However, gains from capital transactions cannot be set off against losses from other heads of income,” said Neeraj Agarwala, partner, Nangia Andersen India.

That means LTCG from real estate transactions can be set off against LTCL from equity transactions, and so on.

In cases where there are no losses available for setting off the gains, there are alternative ways to reduce the tax liability, such as reinvesting the capital gains. One option is to reinvest in capital gains tax exemption bonds, also known as 54EC bonds, which can help save tax on LTCG. These bonds can be purchased with a minimum investment of Rs 20,000, and the maximum investment limit in a financial year is Rs 50 lakh. In the case of jointly-held assets, each owner has a separate limit of up to Rs 50 lakh for investing in these bonds.

Another option to save tax on LTCG is to reinvest the gains in residential property. You can either adjust the gains against any two residential properties purchased in the last one year or two years after the date of transfer of the old house or construct a residential house within three years from the date of transfer of the old house.

It's important to note that the exemption for investment in two residential properties will be available only if the amount of LTCG does not exceed Rs 2 crore. Additionally, once you choose to exercise this option, you will not be eligible to avail of it again in the future.

WHAT IF THERE IS A CAPITAL LOSS?

“Losses on account of capital transactions can be set off only against gains from other capital transactions. Moreover, unutilized losses can be carried forward for a set-off of up to eight years,” said Agarwala.

In Bansal's case, she has the option to either set off her LTCL against any other LTCG she may have, or she can choose to carry forward the LTCL of Rs 1,60,423 to the next year and set it off against any gains she makes in that year. It is important to note that in order to carry forward losses, Bansal must file her income tax return before the due date, which is typically July 31. If she files a belated return, she will not be allowed to carry forward her losses.