A guide to capital gains tax on property sales: Navigating pre- and post-2001 rules

For real estate owners, especially those with long-held properties, the provisions of the Union Budget 2024 came as a rude shock, leaving them scrambling to decipher the new tax landscape.

The overhaul in capital gains tax rules has sparked confusion, especially with the removal indexation benefits. The revised provisions now impose a 12.5% levy on long-term capital gains (LTCG), while short-term gains remain taxed at slab rates. The elimination of indexation, a key tool for reducing tax liabilities on older properties, has left many property owners in a difficult position.

As the dust settles, experts are urging homeowners to carefully reassess their financial strategies, particularly considering the deductions that can still be applied to the cost of acquisition.

For instance, take Mr A, who purchased a house on 15 October 1990, for ₹15 lakh. He spent ₹2.5 lakh on repairs in 2000 and another ₹3 lakh in 2010. Now, Mr A seeks to determine which expenses can be added to the cost of acquisition when selling his house. Notably, the initial stamp duty, costs for improvements and any brokerage or legal fees paid during the purchase, can all be included in the cost of acquisition (CoA).

“The cost of acquisition is the basic price agreed to be paid to the seller and includes stamp duty, registration fee and transfer fees (if applicable). Expenses such as brokerage and legal fees, if these are directly connected with the transaction of purchase of the property, also form part of it. GST on purchase of under-construction property can also be added to it,” said chartered accountant Nitesh Buddhadev, founder of Nimit Consultancy,

Decoding cost of acquisition for pre-2001 properties

While chartered accountants were confident that stamp duty is included in the CoA, confusion surfaced on social media platform X last week about its applicability post-Budget 2024. The debate was so intense that the Income Tax Department stepped in to clarify capital gains tax calculation for properties purchased before 1 April 2001. In a post, they explained that stamp duty is indeed included in the cost of acquisition, albeit with certain conditions.

Read this | Budget is done. Time to review your financial strategy?

"An issue has been raised as to what would be the cost of acquisition as on 1 April 2001 for properties (land or building or both) purchased prior to 1 April 2001. It shall be:

i) Cost of Acquisition of the asset to the assessee; or

ii) The fair market value (not exceeding the stamp duty value, wherever available) of such asset as on 1 April 2001.

Taxpayers can choose either option as per section 55(2)(b) of the Income-tax Act, 1961," the tax department said.

Applying this rule, Mr A's cost of acquisition includes the purchase price ( ₹15 lakh), brokerage and legal fees ( ₹15,000), stamp duty ( ₹75,000), and the cost of improvements made in 2010 ( ₹3 lakh). Improvements made in 2000 are excluded.

"Any repair/improvement done before 1 April 2001 will not be included in the total cost," noted Buddhadev. Thus, the CoA at this stage is ₹15.9 lakh.

The next step is to engage a registered property valuer to determine the property's fair market value (FMV) as of 1 April 2001, using circle rates in the area. For this example, the FMV is assumed to be ₹22 lakh. However, the I-T rules stipulate that the FMV cannot exceed the stamp duty value, here assumed to be ₹20 lakh. Consequently, ₹20 lakh will be the CoA. Adding the ₹3 lakh improvement cost brings the total CoA for tax calculation purposes to ₹23 lakh.

If Mr A sells his property for ₹2 crore after 23 July 2024, he must deduct the CoA ( ₹23 lakh) from the sale price, resulting in ₹1.77 crore. He can also deduct brokerage or legal fees incurred during the sale, typically around 1% ( ₹2 lakh) of the sale value. The total capital gains will thus be ₹1.75 crore. At a 12.5% tax rate, the long-term capital gains tax payable will be ₹21.87 lakh.

Navigating post-2001 acquisitions

The process is more straightforward for properties purchased after 1 April 2001, focusing on the actual purchase price plus associated fees and improvement costs. However, complications can arise when loans are involved, particularly concerning the interest paid.

In these cases, the concept of fair market value doesn't apply. The CoA is simply the sum of the purchase price, associated fees, and improvement costs. For example, Mr B bought a house on 15 October 2005, for ₹50 lakh, with a ₹10 lakh down payment and a ₹40 lakh loan at 8.5% interest over 15 years. He incurred ₹2.5 lakh in improvement costs in 2010, paid ₹2.5 lakh in stamp duty, and ₹50,000 in brokerage and legal fees. The interest on the loan, assuming it wasn't claimed as a deduction under Section 24B or Chapter VI A, amounts to ₹30.9 lakh. Thus, the total CoA becomes ₹86.4 lakh.

If Mr B sells the property for ₹2.5 crore in the ongoing financial year after 23 July 2024, he must deduct the CoA of ₹86.4 lakh and the brokerage/legal fees of ₹2.5 lakh paid during the sale. This results in capital gains of ₹1.61 crore. At a 12.5% tax rate, the LTCG tax payable will be ₹20.13 lakh.

The interest component in the CoA isn't straightforward. The Finance Act 2023 introduced a proviso to Section 48(ii) effective 1 April 2024, saying that "interest claimed under Section 24 or Chapter VIA shall not be considered part of the cost of acquisition or improvement of the capital asset."

Chartered accountant (CA) Naveen Wadhwa, vice president at Taxmann, explains, “The proviso has been introduced as an anti-abuse measure to curtail double deduction, as taxpayers used to claim it under Section 24 or Chapter VIA and also include it in the cost of acquisition when selling a property.”

There remains a question: Can the interest not claimed under Section 24 or Chapter VIA be included in the CoA? Some tax experts say yes, but CA Balwant Jain disagrees.

Jain explained that including interest in the cost of acquisition is only possible until the possession of the house has been obtained. After possession, the interest can only be deducted under Section 24 or Chapter VIA, following broader accounting principles. These principles state that interest paid after the commercial production of a factory is considered revenue expenditure and cannot logically be added to the asset's cost.

“This inconsistency between the commercial principles and section 48 may lead to litigation,” he noted.

Also read | Mint Explainer: The budget, buybacks, and Esop taxation

While calculating the CoA seems straightforward, it's advisable to consult an experienced CA, especially when the deduction of interest payments is involved.