Capital gains on property: Why deny an inflation adjustment?

In life, nothing comes for free. After Tuesday’s budget, add taxation relief. Take the changes in India’s tax regime for capital gains. While investors now have rules that are somewhat easier to recall, thanks to greater uniformity in rates across asset classes and the time limit beyond which assets qualify as having been held ‘long-term,’ the government has extracted a pound of flesh in exchange. 

Both short- and long-term capital gains (LTCG) tax rates on financial assets have been raised—the former to 20% from 15% and the latter to 12.5% from 10%. As with dividends, income-tax slab rates apply to some classes, but the general burden has increased. 

Now, since asset owners have seen the value of their holdings swell quite a bit in recent years, these hikes could be justified on the ideal of progressive taxation: Those who can most afford to pay, ought to be taxed more. But is this really about tax principles? The removal of a crucial indexation benefit for non-financial assets like property suggests not. 

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It existed for a valid purpose, letting taxpayers offset the cumulative effect of inflation on the gains made on the sale of an asset. The real gain made on selling a house, for example, is the difference between what one gets for it and its purchase price inflated at an annual rate to reflect an inflation-updated value. 

Indexation does that, reducing one’s tax liability in line with market reality. Although LTCG on property sales has been slashed to 12.5% from 20%, to align it with other assets, indexation has been retained only for property acquired before 2001.

That cut-off is arbitrary, but it acknowledges the huge difference that indexation makes over long periods. A home bought half a century ago could be saddled with a scary tax bill if inflation were overlooked. But this is also true of property acquired after the 2001 time-bar. 

Remember, inflation compounds over time, eating away what the rupee is really worth. If we assume average inflation of 6.5% every year over the past two decades, ₹1 crore today would be equivalent to about one-third of this figure 20 years ago. 

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Real estate calculations can’t ignore this difference, even if it looks less dramatic as one’s holding period shortens. Can a harsh inflation penalty count as a pragmatic idea? 

The move has been defended by some observers on the argument that it will contain speculation in this field. It could drive away those who invest in houses only to keep them locked, which keeps supply down and prices up in both rental and property markets. Our access to homes could be eased if investors put money into assets like equity instead, letting supply respond better to actual housing needs. 

Admittedly, this could be one positive effect of dropping indexation. But practical solutions can still be unfair. What does the Centre say to people who bought property on the expectation of a stable policy on something as sensible as taking inflation out of the profit calculus? They have a right to feel let down.

Is there a way to escape a hefty tax bill? One could reinvest the proceeds of a sale in a transit house, since this attracts no tax, and then pay LTCG tax on smaller gains by selling it off after two years. This involves a rigmarole, though, and shows our tax rules in a bad light. 

Cash deals could plausibly also rise under the new rule, which would encourage the use of black money. On balance, time-barred indexation is a bad idea. The benefit should be reinstated for all. Evenly applied levies within a class, let’s not forget, are a cardinal principle of taxation.

Also read: For property investors, one step forward and two steps back