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Category: Tax Planning

What are the tax implications of receiving an Inherited Property

The real estate sector in India remains one of the most coveted investment options, often holding significant emotional value for individuals. Many aspire to leave a lasting legacy for future generations through property ownership, much like our ancestors did for us. As a result, acquired properties are often meant to be passed down to the next generation. However, circumstances may arise that lead to the sale of inherited property, and this raises questions about the tax implications of such transactions.

Common queries include:

 

  • Is the entire sale value taxable?
  • Will this sale increase my overall tax liability?
  • Are there ways to mitigate the tax liability?
  • How is the tax liability calculated?
  • If I reinvest in a new property, will it still be taxable?

 

In this article, we will provide answers to these frequently asked questions.

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Tax Implications:

When inheriting a property from an ancestor, there are no immediate tax implications. However, any profits made from selling the inherited property are subject to taxation as capital gains. The capital gain arising from the sale of an inherited property will be fully taxable in your hands.

 

Capital Gains:

The sale proceeds of the property comprise two components: the cost of acquisition (the value you paid when acquiring the property) and the capital gain (the profit from the sale).

 

Sales Value - Cost of Acquisition = Capital Gains

 

While the cost of acquisition is tax-free, the capital gain is subject to taxation. The calculation of capital gains depends on the holding period of the property. Note that the holding period is determined from the date of purchase by the ancestor, not the date of transfer to you.

 

Short Term Capital Gains (STCG):

Any gain from the sale of a property within 24 months (previously 36 months) of acquisition is considered STCG. The amount from STCG is added to your income and taxed accordingly.

 

Long Term Capital Gains (LTCG):

 

LTCG arises from property held for more than 24 months (previously 36 months) from the acquisition date. LTCG is calculated at 20%, with the benefit of indexation. The LTCG is determined as the difference between the net sale proceeds and the indexed cost of acquisition.

 

LTCG = Sales Proceeds - Indexed Cost of Acquisition

 

Indexation: Indexation is a method that adjusts tax payments by factoring in inflation. It allows you to inflate the purchase price of the asset to account for inflation's impact. The Indian government uses the Cost Inflation Index (CII) as a tool to measure inflation. The indexed cost of acquisition is calculated as follows:

 

Indexed Cost of Acquisition = Purchase Value of the Property * (CII of the Current Year / CII of the Acquisition Year)

 

For example, if Mr. X inherited a property from his father in 2015, which his father had acquired in July 2005 for Rs. 20,00,000, and Mr. X sold the property this financial year for 1 crore, the LTCG for this transaction would be:

 

LTCG = 1,00,00,000 - Indexed Value of 20,00,000

Indexed Value = 20,00,000 * (208/117) = 35,55,555

LTCG = 1,00,00,000 - 35,55,555 = Rs. 64,44,445

 

Mr. X can consider 35,55,555 as tax-free, and for the remaining amount, he must pay an LTCG tax of 20% on 64,44,445. Additionally, he can avail tax exemption by investing in Capital Gain bonds for a maximum of Rs. 50,00,000 in a financial year or by purchasing a new property.

 

Tax Implication on Buying a New Property:

Section 54 of the Income Tax Act allows you to reduce your capital gains by the amount invested in purchasing a new house property. This exemption is limited to the total capital gain from the sale. You can buy the new property either one year before the sale or two years after the sale of your property. You can also invest the gains in constructing a property, but it must be completed within three years from the sale date. However, please note that this exemption can be revoked if you sell the new property within three years of its purchase.

 

While acquiring a new property involves finding a suitable seller, securing funds, and handling paperwork, the Income Tax Department understands the associated challenges. If you are unable to invest your capital gains by the date of filing your return, you can deposit them in a PSU bank or other banks under the Capital Gains Account Scheme, 1988. This deposit can be claimed as an exemption from your capital gains in your return. However, you must invest this money within the specified period; failure to do so will result in your deposit being treated as capital gains.

 

Conclusion:

There is often confusion regarding the tax implications of selling inherited property. While some believe that the proceeds from the sale of an inherited house are entirely tax-exempt, others assume that they are fully taxable. In reality, there are no immediate tax implications upon inheritance. However, any profits from selling an inherited house are subject to taxation as capital gains. Selling the inherited property and reinvesting in a new property has become one of the most effective means of tax savings due to the increased lock-in period for capital gain bonds (from 3 to 5 years).

 

 

Published on September 27, 2018.

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