In recent years, investments in real estate have been gaining more traction, and an increasing number of investors are buying property.

Reduce Taxes When Selling Property

Real estate investments have been gaining popularity as of late, with an increasing number of investors buying property with the intention to sell it in the future and earn substantial returns. The taxation of real estate transactions is typically a hotly contested topic due to the fact that real estate deals typically involve extremely large sums of money. In this article, we will investigate the tax structure of indexation and how it can help reduce the amount of tax that must be paid.

Capital gains on sale of property

As an illustration, let us assume that a property was purchased in the year 2000 for the price of R10 lakh, and that it was sold in the year 2015 for the price of R50 lakh; in this scenario, the profit is R40 lakh. Nevertheless, this is only a hypothetical gain. When calculating the real profit, it is important to take into account how the cost of purchasing the property has changed due to inflation. This is comparable to the disparity that exists between the real interest rate and the nominal interest rate, where the real interest rate is calculated by subtracting the inflation rate from the nominal interest rate (which any investment pays).

The issue of the tax that needs to be paid on the transaction is something that the sellers have to deal with once the property has been sold.

The nature of the capital gain is the primary determinant of the tax liability that will be incurred. Short-term capital gain refers to the profit made on the sale of a property within the first three years after it has been purchased (STCG). The seller must then add the profit to their income before being taxed on it according to the income tax bracket that they are in. Therefore, as an illustration, if an investor is placed in the tax bracket of 30 percent, the gains will also be subject to taxation at that rate.

When a property that has been owned for at least three years is put up for sale, any profit made on the sale is considered long-term capital gain (LTCG). The long-term capital gains tax rate is a flat twenty percent of the profit. When calculating profits, the indexation method is used, which results in a significant reduction in the amount of tax that must be paid. It is recommended to investors that they search for the most recent data on tax rate and indexation in order to ensure that the appropriate taxes are paid.

What is indexation?

Indexation refers to the process of rationalising the price at which a property was purchased on the basis of inflation. The new price was calculated using the cost inflation index (CII), which is a number that indicates the relative level of inflation in each year. This new price was determined. Therefore, in the event that the CII doubles within five years, the original cost should also be considered to be twice as high as the indexed cost. The CII is a value that is determined by the Reserve Bank of India. The Reserve Bank of India publishes this value on an annual basis so that it can be used for indexation purposes.

An illustration

Continuing with the earlier illustration, the long-term capital gain is qualified for the long-term capital gains tax category because the property was held for 15 years. As a result, the indexation can be applied to the process of calculating the amount of tax that needs to be paid to the government.

To begin, it is necessary to locate the CII data for the years 2000 and 2015. According to the information that was made public by the RBI, the value of the CII in the year 2000 was 389, but in the year 2015, it was 1,024. To determine how much indexation should be applied to the initial cost, take the ratio of these two numbers.

Because of this indexation, the initial cost of ten thousand rupees, which was indexed to twenty-six hundred thousand rupees. Therefore, the long-term capital gain is 23.7 million rupees when the profit is calculated using the new indexed cost. Now the taxes have to be paid on 23.7 million rupees rather than on 40 million rupees. Because the tax rate on LTCG is 20 percent of the profit, the tax liability will be Rs. 4.7 lakh since that is the amount that will be owed.

In the same vein, sellers are able to keep track of the costs involved in the ongoing maintenance of the property. By deducting these costs from a property transaction's profit, the taxpayer is able to reduce their overall tax burden and potentially save money on property transactions.

Profits after Taxes:

If the property is sold within three years of the date it was purchased, the profit is subject to STCG, which means that it is added to the seller's income and taxed according to the seller's income-tax slab.

When a property is sold after three years of ownership, the profit is subject to long-term capital gains taxation, and the rate of taxation is a flat 20% of the profit.

The indexation method is used to calculate profit, which results in a significant reduction in the tax liability.

It is recommended to investors that they search for the most recent data on tax rates and indexation in order to ensure that the correct taxes are paid.