Capital Gains on Sale of Gifted Assets - Provision and Implications

The primary purpose of any investment or asset acquisition is to earn money above the capital. Interest on a fixed deposit, mutual fund returns, dividends, and asset transfers profit are all capital gains. In short, capital gains serve as an incentive to investors.

What if you end up selling a piece of land you have inherited or received as a gift from your parents or ancestors? This can also give rise to capital gains based on how you invest or capitalize the asset. Let us understand the tax implications of capital assets on the sale of gifted assets.

Budget 2024 Latest Updates

Budget 2024 has passed the following amendments effective from FY 2024-25 - 

• For classifying assets into long-term and short-term, there will only be two holding periods: 12 months and 24 months. The 36-month holding period has been removed.
• The holding period for all listed securities is 12 months. All listed securities with a holding period exceeding 12 months are considered Long-Term. The holding period for all other assets is 24 months.
• The taxation of Short-Term Capital Gain for listed equity shares, a unit of an equity-oriented fund, and a unit of a business trust has been increased to 20% from 15%. Other financial and non-financial assets which are held for short term shall continue to attract the tax at slab rates.
• For the benefit of the lower and middle-income classes, the limit on the exemption of Long-Term Capital Gains on the transfer of equity shares or equity-oriented units or units of Business Trust has increased from Rs.1 Lakh to Rs.1.25 lakh per year. However, the rate at which it is taxed has increased from 10% to 12.5%. The exemption limit to Rs. 1.25 lakhs has been increased for the whole of the year, whereas the tax rate changed on 23rd July 2024.
• The tax on other assets is reduced from 20% to 12.5% with effect from 23rd July 2024. On the other hand, the indexation benefit that previously was available on the sale of long-term assets has now been eliminated. However, the Government has given taxpayers an option to compute taxes on real estate transactions purchased before 23rd July 2024 either at 12.5% without indexation or at 20% with indexation. 

Capital Gains on Sale of Inherited or Gifted Assets

When an individual gifts any asset, movable or immovable, tax is imposed on the sale of asset. When the person receiving the gift further sells it, he/she will have to pay capital gains tax upon the sale of the gifted assets.   

When assets are inherited or gifted and subsequently sold by the taxpayer, it gives rise to capital gains. Taxpayers will have to pay the short-term or long-term capital gains tax on the profit from the sale of such assets.

Capital Gains Computation on Sale of Gifted Assets

The sale of a capital asset held by you will result in short-term or long-term capital gains, depending on the duration for which you have held the asset. The duration for treating an asset to be short-term or long-term differs from asset to asset. For instance, a house property held for less than 2 years is short-term, whereas if held for more than 2 years would be considered long-term. However, for listed equity shares, the short-term duration is less than 12 months, and the long-term duration is more than 12 months.

Further, gains from short-term assets are determined by using the simple formula of: Sale Consideration – Cost of acquisition (Purchase Price) – Cost of improvement

Whereas, gains from the sale of long term assets are determined using the below formula: Sale Consideration – Indexed Cost of Acquisition – Indexed Cost of Improvement

You may see that for long term assets, law provides taxpayers the benefit of indexation, which would help factor in the impact of inflation in price over a period of time. This indexation benefit that was previously available on sale of long-term assets, has now been done away with effect from FY 2024-25. However, this faced a backlash from the public. So, the Government has passed an amendment that allows taxpayers to compute taxes either at 12.5 per cent without indexation or at 20 per cent with indexation on real estate transactions. The amendment will apply not only to real estate transactions but also to unlisted equity transactions, which are done before July 23, 2024.

Determining Cost of Acquisition

Moving on to the computation mechanism, when an asset is gifted or inherited, the taxpayer cannot attribute a purchase price to the asset. To address this, the law itself has discussed certain scenarios. This includes a case of gift or inheritance, where the purchase price of the previous owner would be treated as the purchase price for computing capital gains of the taxpayer. Additionally, the cost of improvement of the asset borne by the previous owner will also be included in the cost of acquisition. Thus, the cost of purchase plus the cost of improvement will be the cost of acquisition.

Example 1: Rahul’s father gifted him a flat in June 2017. His father had purchased the flat in 2012 for Rs 40 lakh. Rahul proposes to sell this flat in September 2019 for a consideration of Rs 50 lakh. Therefore, Rahul would compute his capital gains from the sale of this flat by considering the purchase price of his father, i.e. Rs 40 lakh.

Example 2: Disha received a house property as a gift from her father in 2016. She sold the property in Feb 2020. Her father bought the property in 2014, and later in 2015, he made some improvements to the building. Here, Disha should consider the improvement cost made by her father along with the purchase cost while calculating long-term capital gains. She can also get the indexation benefit.

Determining period of holding

Many court verdicts and tax tribunals have held that for gifted or inherited property (capital asset), the period of holding should be considered from the time the previous owner acquired it. An asset would be classified as short-term or long-term based on such a holding period.

Example 1: Rahul’s father gifted him land in June 2019. His father had purchased the land in 2010 for Rs 40 lakh. Rahul sold the land in September 2020 for a consideration of Rs 80 lakh. The period of holding of the property would begin from the year 2010 itself (the year of purchase by the father), and accordingly, the asset would be classified as long-term, and Ramesh will have to pay long-term capital gains tax. He can avail the benefit of indexation too.

Example 2: Disha’s mother gifted her a flat in May 2019. Her mother purchased the land in June 2018 for Rs 40 lakh. Disha sold the flat in December 2019. Since she received the asset as a gift, the cost of acquisition will be the same as the cost of purchase by her mother, i.e. Rs.40,000, and the period of holding will start from the day when her mother bought the flat, i.e. June 2018. Since Disha sold the flat within two years from June 2018, she must pay short-term capital gains tax.

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Section 54F