The ‘pagdi’ system is a slightly different form of tenancy in India, where the tenant acquires tenancy rights in the property against payment of ‘pagadi’ to the property owner. The tenant here becomes the co-owner of the property and continues to pay nominal rent, compared to the market rates, to the owner as long as they are not sub-renting the premises. This system is commonly found in parts of Maharashtra, Delhi and Kolkata. Additionally, the tenant has the choice to sell the said property in the ‘pagadi’ system.
If you are living in a house on a ‘pagdi’ basis, you are not the owner of the house from a tax perspective. Therefore, when you vacate and get compensation, it is not the sale price of a house. You are only transferring the ‘right’ to live in the house.
So, the transfer of your tenancy right is covered under the definition of the term’ capital asset’ under the Income Tax Act. Hence, you must pay capital gains tax on the profits realised on the sale/transfer of a capital asset. It may be long-term or short-term capital gains depending on the holding period of the asset sold. Any amount over the cost of the tenancy right is to be taxed as capital gains. If the tenancy rights are transferred after three years of the date of acquisition, the profits would be treated as long-term capital gains.
Moreover, if you have acquired the tenancy rights before 1st April 2001, then you must calculate capital gains considering the Fair Market Value (FMV) of the tenancy right as of 1st April 2001 as the cost. Apply the indexation on the FMV and compute the long-term capital gains. Obtain a valuation report from a registered valuer to know the FMV of the tenancy rights. The money received in excess of the indexed FMV will be long-term capital gains, and a 20% tax will be payable.
You can save tax on long-term capital gains from the transfer of tenancy rights by investing the net consideration in purchasing/constructing a residential house. Such exemption can be availed of under Section 54F of the Income Tax Act on satisfying the conditions provided. The capital gain exemption will be proportionately reduced if you don’t invest the whole of the consideration received. Since tenancy right does not mean a residential house, land or building, you cannot claim an exemption under Section 54 and Section 54EC, respectively.
If the holding period of tenancy rights is less than three years, calculate the short-term capital gains by reducing the cost of tenancy rights with the consideration received. Tax on such gains is payable at the applicable income tax slab rates.
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