With Or Without Indexation: When Do Homeowners Pay Less?

Calculating taxes under both methods—considering inflation and property appreciation—can yield a more precise result

In Union Budget 2024-25, the government removed the indexation benefits on sale of property. Union Minister of Finance Nirmala Sitharaman announced the removal of indexation benefits for property sales and reduced long-term capital gains (LTCG) tax from 20 per cent to 12.5 per cent. So, if you are selling a property, the difference between the buying and selling price will be taxed at a flat rate of 12.5 per cent.

However, on August 7, 2024 after an outrage by investors, some of whom would have needed to pay higher tax with the removal of indexation, the government declared an amendment to the Finance Bill, 2024.

“The amendment states that taxpayers can choose to either use indexation and pay a 20 per cent tax rate or forgo indexation and pay the reduced 12.5 per cent rate, allowing them to select the option that minimises their tax liability,” says Ridhima Bhatia, deputy general manager, Taxmann, a tax consultant.

These two options have been provided to individual taxpayers and Hindu Undivided Families (HUFs) under both new and old tax regimes.

The availability of two options has however, created confusion. Let’s first understand how indexation benefit works, and then analyse which works better for you.

Indexation Benefit

Indexation is a process where the original purchase price of an asset is indexed to inflation, allowing the taxpayers to factor in inflation when paying capital gains. The buying price of a property is revised upwards for the period for which it was held, reducing the capital gains amount.

For instance, if you bought a residential plot in April 2010 for  Rs 10 lakh and sold it in April 2024 for Rs 25 lakh, the profit or capital gain before applying indexation would be calculated by the following formula: Capital Gain = Selling Price - Purchase Price. The capital gain will be Rs 25 lakh - Rs 10 lakh = Rs 15 lakh.

Now, let’s see how indexation will affect this calculation. The government provides a cost inflation index (CII) for every financial year.  This index number reflects how much prices have increased over time. In this case, CII for 2010 was 167 and CII for 2024 was 348.

To adjust the purchase price for inflation, you use the following formula to reach the indexed cost of purchase. Indexed Cost of Acquisition = Original Purchase Price × (CII of sale year / CII of purchase year). Going by the above formula, the indexed cost of acquisition will be Rs 10 lakh X (348/167), or Rs 20.80 lakh.

The capital gain after applying indexation will be the Selling Price - Indexed Purchase Price. So the indexed capital gain will come to Rs 4.20 lakh (Rs 25 lakh - Rs 20.80 lakh), down from Rs 15 lakh without indexation.

Now let’s apply the applicable tax rate on these amounts.

The capital gain without indexation, Rs 15 lakh, will be taxed at 12.5 per cent, which will come to Rs 1,87,500. The indexed capital gain amount of Rs 4.20 lakh will be taxed at 20 per cent. So your tax payable will be Rs 84,000.

Here, the indexation of 20 per cent tax results in a lower tax liability.

What Works For You?

In some cases, depending on the price of the property and the price appreciation rate, you will lose if indexation is removed and pay a flat 12.5 per cent LTCG tax rate. However, in other cases, availing of indexation along with the 20 per cent tax rate will be better. So how do you choose?

“There is no definitive method to determine what option to choose, but calculating taxes under both methods—considering inflation and property appreciation—can yield more precise results,” says Shrinivas Rao, CEO, Vestian Research, an international property consultant.

Thus, tax calculation under both methods is crucial for making an informed decision tailored to individual circumstances. We spoke to experts to do a calculation in certain scenarios and with certain assumptions. The calculations show that if you have held the property for 5 years and the appreciation rate is 10 per cent, only then will the flat rate of 12.5 per cent work for you. In all other scenarios given the assumptions, it would make sense to go for a LTCG of 20 per cent with indexation benefits (see What Should You Choose?).

Says Anuj Puri, chairman, Anarock Group, a real estate services company: “For properties held over a long period, where inflation has majorly raised the property’s value, going for the 20 per cent tax rate with indexation would be beneficial. Indexation adjusts the purchase price for inflation, thus reducing the taxable gain and overall tax liability. For properties held for shorter periods or in low-inflation periods, the 12.5 per cent rate without indexation could be more beneficial.”

The move has definitely given flexibility to homeowners looking to sell a property. “This will give them flexibility to at least consider both the options rather than being imposed with one,” says Ritika Nayyar, partner, Singhania & Co., a law firm.

What Does It Mean?

The government has rationalised LTCG tax on property sales. On one hand, they have looked at more tax revenue, while on the other, they have given clarity and resolved any apprehension that taxpayers may have had on removal of indexation benefits.

But certain sections are not happy with the rollback and the way it has been announced. Says P.V. Subramanyam, a chartered accountant, author and trainer, in a webinar conducted by Outlook Money recently, “The amendment is only available for individuals, and not for non-resident Indians (NRIs), partnership firms or companies. If they want to remove indexation, they should stop indexing government salaries and pensions, too.”

Says Harsh Roongta, a Securities and Exchange Board of India)- registered investment advisor (Sebi-RIA), at the same webinar, “It’s unfair. You may save tax but what about other aspects. I think a very senior official mentioned that stamp duty is not deductible while calculating the cost. But there is no amendment in law regarding this. So, there will be confusion at the time of filing taxes.”

How this turns out is something we will have to wait and watch.

meghna@outlookindia.com