How to calculate income tax liability if you sell your ancestral property

Any person selling a property inherited from his/her ancestors is not required to pay tax at the time of inheritance. The tax event arises when the person sells such inherited property.

The income tax liability on property sales depends on the holding period. If the period of holding the property is less than 24 months from the date of acquisition, the gain on sale of such property is termed as short-term capital gains and taxed at regular slab rates applicable to the person. But if a property is sold after 24 months of purchase, gain on sale of such property is termed as long-term capital gain, and tax liability would be 20.8% (including cess) on such gains. However, for the inherited properties, the seller has to calculate the holding period from the date of purchase or acquisition of such property by the original owner who actually purchased the property and not from the date of inheritance.

If there is a long-term capital gain, the taxpayer can adjust the impact of inflation on the acquisition cost by taking the Cost Inflation Index (CII) into account. If there has been any major repair or improvement to the property, the cost of such repairs and improvement should be adjusted against inflation by applying CII. The government notifies the CII for various financial years. 

The taxpayer can apply CII by multiplying the property’s purchase price with the CII of the financial year in the year of sale and dividing the product by the CII of the financial year in which the original owner purchases it.

                                                            Cost of acquisition of the property x CII of the FY property sold

Indexed cost of acquisition=  —————————————————————

                                                            CII of the FY property purchased by the original owner

For example, Mr Manish purchased a property on 1st August 2004 for Rs 75 lakh. Aarti inherited this property from her father in 2012. However, she decides to sell this house. In May 2014, Neha sold this house for Rs 1.8 crore.

In this case, Aarti has no tax payable at the time of inheritance of her father’s property. The purchase cost for calculating Aarti’s capital gain shall be Rs 75 lakh, and it should be indexed since it’s a long-term capital gain (property sold after 24 months). For indexation, the Cost Inflation Index (CII) for 2004-05 and 2014-15 should be considered.

Therefore, the cost for calculating capital gains for Aarti will be:

Rs 75 lakh x CII of 2014-15 / CII of 2004-05

= Rs 75 lakh x 240 / 113

= Rs 1.6 crore.

The net gain for Aarti is Rs 20 lakh (Rs. 1.8 crore-1.6 crore).

Hence, the date or year of inheritance is of no importance while calculating the capital gains tax on inherited properties.

If the original owner acquires the property before 1st April 2001, the seller of the property has the option to take the fair market value (FMV) as of 1st April 2001 or the actual cost of acquisition for calculating the indexed cost of the property. To obtain the property’s fair market value as of 1st April 2001, the seller of the property has to get in touch with a valuer of the property and obtain a valuation report from him. On this FMV, the seller has to apply the CII and arrive at ist indexed cost.

Tax benefit

If there is a long-term capital gain, the taxpayer can claim exemption on the gains made from the sale of inherited property. If the property is a residential property, the taxpayer can re-invest the capital gains in another residential property and claim the exemption up to the amount re-invested.

The taxpayer can claim the exemption by re-investing the capital gains across a maximum of two residential properties in India, provided the long-term capital gain is less than Rs 2 crore. If the long-term capital gain is more than Rs 2 crore, the taxpayer can claim the exemption only for re-investment made in one residential property. The taxpayer should invest within the specified time frames, i.e., one year before or two years from the sale date.

The taxpayer can also claim the exemption for capital gains invested for an under-construction property. For the house under construction, the taxpayer should utilise the gains within three years from the date of sale of the property.

The taxpayer has another option to invest the long-term capital gains in capital gains bonds under Section 54EC of the Income-tax Act. The total investment limit in these bonds is restricted to Rs 50 lakh per FY.

For any clarifications/feedback on the topic, please contact the writer at namita.shah@cleartax.in