Tax on capital gains and rental income from inherited property

An individual may inherit property under a will or through succession. The method of inheritance depends on the personal laws of the individual, such as Hindu or any other religion. In the case where there is a ‘Will’, the succession happens as per the ‘Will’. However, in the absence of a ‘Will’, for a Hindu, the inheritance occurs as per the Hindu Succession Act. 

In India, at present, there is no income tax on the inheritance of property. However, there is an income tax liability on income earned from such property. For example, the rental income earned from the property gets taxed as income from house property. The sale of the inherited property gets taxed as capital gains. 

Tax on rental income from the inherited property:

Do note that while you offer the income from the inherited property, you also complete the legal formalities necessary to transfer the ownership to yourself in the municipal records. An ownership transfer enables you to take a housing loan for reconstruction and repairs. In the case of letting out of the property, you can claim the municipal tax you pay and the interest on your housing loan. You may take a loan for reconstruction of the property and claim the interest deduction. You may take a loan for repairs and claim an interest deduction. The limit on the deduction for interest on housing loan is:

Interest deduction Let-out property Self-occupied property
Reconstruction Full amount up to a loss of Rs 2 lakh from the house property Rs 2 lakh
Repairs Rs 30,000

Besides the interest deduction, you can also claim a deduction for the principal portion of the EMI up to Rs 1.5 lakh per financial year.

Capital gains on the sale of inherited property:

In the case of a sale of immovable property, you need to pay the capital gains tax. A property whose holding period is more than two years is a long-term capital asset. The holding period begins from the date of purchase by the original owner and not just the date of inheritance. For example, if you inherited a property purchase by your father in 1980, the holding period begins from the date of original purchase. 

While calculating capital gains, you can claim the benefit of indexation of the original cost and cost of any improvements or additions to the property. You need to use the cost inflation index notified by CBDT.

Also Read: Income tax benefits after availing a housing loan

Indexed cost of acquisition/improvement = Purchase cost/Cost of improvements x Cost inflation index of the year of making the sale / Cost inflation index of the year of original purchase/improvement or FY 2001-02.

However, in the case of property purchased before 1 April 2001, you can either consider the ‘original cost plus improvements’ incurred before 1 April 2001 or opt for the ‘fair market value’ of the property existing on 1 April 2001. You can choose what is beneficial and index the same using the cost inflation index.

Your long-term capital gains = Sale consideration reduced by expenses on transfer and indexed cost of acquisition/improvement. The ‘expenses on transfer’ include brokerage/commission, expenditure incurred on the transfer of ownership in case of inheritance and succession of the property.

Saving capital gains tax on inherited property:

The capital gains tax rate is 20% plus cess and applicable surcharge. However, there are certain options available for saving capital gains tax. An individual can claim capital gains exemption by investing in a residential house either by purchasing or constructing a new house. The time allowed for purchase is two years from the sale date or one year before the sale. In the case of construction, the time allowed is three years from the sale. You need to invest the net sale consideration (sale consideration reduced by expenses on transfer). In case the new house is yet to be purchased or constructed/construction in progress, you should deposit the unutilised sale consideration in a capital gains account scheme before filing ITR within the due date.

You can also save the capital gains tax by investing in notified long term bonds issued by the Rural Electrictrification Corporation Limited or National Highways Authority of India. You can save by investing the capital gains up to a maximum of Rs 50 lakh. The last date to invest in 54EC bonds is six months from the date of sale. The bonds carry a lock-in period of five years.

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

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