Real estate investment is a big investment for all of us, but there is much confusion over capital gain tax on real estate, tax policies, tax brackets, indexation etc. While most of us buy home to live in, there is increasing number of investors who invest in real estate to trade and make money through price appreciation. The charm of real estate as an investment has gone down since last couple of years but there will be demand in very near future. Most of the investors, while very adept at buying properties, find it hard to deal with taxation after selling the property. In this article, we will clarify some of the taxation issues related to real estate investment.
Taxation policy in real estate
The profit accrued because of selling the property at a higher price than purchase price is known as capital gain. Tax over it is called capital gain tax. Capital gain tax is of two types, short term capital gain tax and long term capital gain tax.
The short term capital gain tax is applicable when the transaction happens within 3 years. This means if an investor buys a property and sells it within 3 years; he or she is liable to pay short term capital gain tax. This income from short term capital gain is added to the investor’s income and then taxed as per the tax bracket the investor falls under. For example, if an investor pays 30% tax on the income, he or she will have to pay short term capital gain tax at the same rate of 30%.
If the transaction happens after 3 years, the tax liability will change to long term capital gain tax. This means if an investor buys a property and sells it after 3 years, he or she will have to pay long term capital gain tax. The long term capital gain tax is 20% post indexation.
The concept of indexation
You bought a property in 2001 in New Delhi at Rs 20 lakhs. Today you want to sell it and you go to a real estate agent to find out what should be the price of the property you own. The real estate agent tells you that the price is Rs 50 lakhs. Prima facie, it looks as if you have to pay taxes on 30 lakhs as this is your profit. The price has appreciated since 2001 and hence you are getting a higher price. However, this calculation doesn’t consider two major components which add to price appreciation:
- 2.Maintenance cost of the property
To adjust to inflationary impact on the property, RBI comes up with an index known as cost inflation index (CII). This index recalculates the cost of property in today’s price and then subtracts with selling price to come up with the capital gain. This reduces your tax liability.
Maintenance cost is further subtracted from your profit to come up with the final number. This reduces your tax liability further.
An investor, named Sushant, bought a property in in Hitec City at Hyderabad at a price of 30 lakhs on 30th Jan, 2000.
Short term capital gain calculation:
Suppose Sushant sells the property in May, 2002 at a price of 40 lakhs. Since he sells the property before 3 years, he will have to pay short term capital gain tax. The profit of 10 lakhs will be added to his income and the tax will be charged as per the tax bracket he falls into.
Long term capital gain calculation:
Suppose Sushant sells the property in Feb, 2004 at a price of 45 lakhs. His notional profit is 15 lakhs. However, he will not pay tax on 15 lakhs because of indexation benefit. Here is how to calculate his tax liability.
Find out the cost inflation index for the year when the property was bought and the property was sold. You can find this on internet or in RBI’s site.
Cost inflation index for 2000 = 389
Cost inflation index for 2004 = 463
Find the inflation adjusted price of acquisition.
Inflation adjusted acquisition price of the property = (463/389) * 30 lakhs = 35.71 lakhs
Find out if any amount was spent in the maintenance of the property.
Suppose Sushant spent 1 lakh in maintenance of the property.
Find out the tax liability.
The taxable profit will be = 45 – 35.71 – 1 = 8.29 lakhs.
Long term capital gain tax will be 20% on this amount = 8.29 * 20% = 1.658 lakhs.
Taxation policy is not really complex but our fear of taxman makes it so. In case of any doubt, income tax department’s website is a good reference for any question.
Note: Tax liabilities may change in individual cases because of different situations. This article gives you just an idea about capital gain taxes. Please contact your income tax advisor or CA for your case.
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