Capital Gains on Sale of Gifted Assets - Provision and Implications

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

Gifts received from relatives are exempt from tax in India. But what if you end up selling a gift received from your parents or ancestors? If the gifted asset sold is land, property, jewellery, or any other capital asset, it will result in capital gains. Let us understand the tax implications of capital gains on the sale of gifted assets.

Capital Gains on Sale of Inherited or Gifted Assets

As per the provisions of the Income Tax Act 1961, any gift received from a relative is exempt and is not taxable. However, if the gift is sold or transferred by the receiver further, then it will be taxed at the time of transfer. In case of a transfer of a capital asset, the capital gains will be taxed.  

In simple words, when capital assets are inherited or gifted and subsequently sold by the receiver, 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 holding period of the asset. The duration for treating an asset to be short-term or long-term differs from asset to asset and are given in the following table

Further, gains from short-term assets are determined by using the simple formula of: Sale Consideration – Expenses related to Transfer – 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 – Expenses related to Transfer – Cost of Acquisition – Cost of Improvement. 

However, the taxpayer has the option to opt for the indexation benefit but with a higher tax rate. In such a case the formula will be: Sale Consideration – Expenses related to Transfer – 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 for long-term assets, has now been removed 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.

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 The 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.

Final Word

The practice of gifting capital assets and inheritance is quite common. However, when such capital asset is sold by the receiver the concept of capital gains arises which should be dealt with accordingly in compliance with the tax provisions. This article gives a detailed explanation of taxation for such a transfer.     

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