How To Calculate Capital Gains On Sale Of Inherited Property?

When a property is received on inheritance or as a gift, it is not taxable for the receiver. When the inheritor or the receiver of this gift of property sells it, capital gains on the sale are taxable for the inheritor. the inherited assets may include immovable property and movable assets like gold, shares, deposits,etc. In this article, you will learn about tax implications on sale of inherited property.

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 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. 

What is Inherited Property?

The property passed down or transferred to the legal heirs of a deceased person is called inherited property. Such property received by the legal heir is said to be their inheritance. Legal heirs of a deceased person can be a spouse, children, mother, grandchildren etc. In India, the rules regarding property inheritance are regulated by personal laws like the Hindu Succession Act 1956 and the Indian Succession Act 1925. 

Legal heirs can inherit property through a will or under the law of succession. A person can also inherit property through a gift deed executed by a family member.

What is Inheritance Tax?

Inheritance tax is the income tax liability in the hands of the recipient if he has received any assets through inheritance/will. However, in India, as per section 56(2)(x), any money or property received under a will or by way of inheritance is not taxable.

Taxation on income derived from an inherited property can be viewed as income tax imposed on an individual due to his/her inheritance. In many cases, inherited property provides additional income to the new owner, such as interest, rent, etc. As a result, the new owner must declare this additional income while filing income tax returns and pay taxes on it.

Taxation on Inherited Property

In India, the inheritance or estate tax was abolished in 1986. Thus, there is no tax liability at the time of inheritance as per section 56(2)(x). However, an owner of inherited house property is liable to pay taxes on income which is generated from the inherited assets and when he sells those inherited assets.

Example: If you have received a house property in inheritance and you receive rental income. You will be liable to pay taxes on the same. Similarly,  if you sell the house during the year it will be taxed under the head “Capital gains”

Taxation on Selling Inherited Property

The owner of the inherited property is liable to pay the capital gains tax upon the sale of the inherited property. Any asset received as an inheritance is exempted from gift tax, but the amount received from the subsequent asset's sale is not exempted and is taxable under the category of capital gains. 

Capital gains can be long-term or short-term, depending on the period for which the asset was held. If the inherited property was owned for two years or more, the income received from its sale is considered a Long Term Capital Gain (LTCG). 

For the calculation of capital gains on the sale of inherited property, the holding period begins from the time the previous owner bought or acquired that property. Thus, in most cases, an inherited property is eligible for the LTCG tax.

The capital gains on the sale of inherited property are as follows:

• When the property is held for more than 24 months from the date of its acquisition, the gains from the property will be termed as Long-Term Capital Gains. (LTCG) and will be taxed at 20% with indexation. However according to Budget 2024  tax is reduced 
• When the property is held for less than 24 months from the date of acquisition, the gains from the property will be termed short-term Capital Gains (STCG) and are taxed at the slab rate applicable to the taxpayer.

Capital Gain Computation

Procedure to Calculate Capital Gains Of Inherited Property

The procedure to calculate the capital gains of inherited property is given below:

Step 1: You must know the cost of acquisition and indexation in order to calculate the capital gains. 

Step 2: Cost of the property – The property did not cost anything to the inheritor, but for calculation of capital gain the cost to the previous owner is considered as the cost of acquisition of the property. If the property was purchased by the previous owner before 1st April 2001, then F.M.V as of 1st April 2001 or the actual cost, whichever is higher, can be considered as the Cost of acquisition.

Step 3: Indexation of cost** - The year of acquisition of the previous owner is considered for the purpose of indexation of the cost of acquisition along with the year of sale of the property. 

Step 4: The base year for such calculations starts from 2001. 

Step 5: Calculate the cost of capital gains using the formula, 
Cost of acquisition x ( Cost inflation index of the year of sale / Cost inflation index of the year of acquisition) 

Where Cost Inflation Index (CII) varies every financial year, and details of such CII Index are available here . The Cost Inflation Index (CII) for the financial year 2023-24 is 348.

Step 6: Subtract the cost of capital gain from the selling price of the property to know the net gain of the transaction. 

Illustration

Mr Arora purchased a property on 1 August 2004 for Rs.75 lakh. Neha inherited this property from her father in 2012. However, she decided to sell the house. In May 2023, Neha sold this house for Rs.3.00 crore.

In this case, the cost for calculating Neha’s capital gain shall be Rs.75 lakh, and the cost shall be indexed since it’s a long-term capital gain. For the purpose of indexation, the CII for 2004-05 shall be considered. 

The capital gain calculation will be as follows

Do note that the date or year of inheritance is of no importance in this calculation.

**It is important to note that the indexation benefit that previously was available on sale of long-term assets, has now been done away with with effect from FY 2024-25.  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. 

How to Save Capital Gains On Inherited Property?

Taxpayers can save capital gains tax on the sale of inherited property in the following ways:

• Section 54EC Bonds: Invest the sale proceeds in bonds of the Rural Electrification Corporation Ltd (RECL), National Highway Authority of India (NHAI), Indian Railways Finance Corporation Limited (IRFC), and Power Finance Corporation Ltd (PFC) within six months of selling the inherited property. However, the maximum eligible investment amount exempt from capital gains tax is Rs.50 lakh in a financial year.
• Section 54 Exemption: Constructing another house from the sale proceeds within three years or purchasing another home from the sale proceeds before the sale or within two years from the sale date of the inherited property. A taxpayer can buy up to two residential properties, and the exemption allowed on the LTCG is up to Rs.2 crore. Also, there is an overall threshold limit of Rs 10 Cr. for a claim of exemption from FY 2023-24 onwards (As per Finance Act 2023).
  • As per the Capital Gains Account Scheme, 1988, the proceeds from the sale of inherited property can be invested in the 'Capital Gains Account' of any authorised bank, except for some rural branches. Further, ensure that the deposited amount is utilised within three years of such transfer, else the deposited sum will be treated as a  Long term capital gain from the day three years are over.

Points to Remember

• In the case of inherited property, the aggregate period of holding is counted from the date of purchase of the property by the original owner and not from the date a legal heir or family member inherits it.
• There is no tax impact at the time of transfer of such capital assets due to Inheritance is non-taxable even as per section 56(2)(x).
• Any amount spent on repairs, additions, or improvements to the property needs to be adjusted when calculating long-term capital gains.
• If the original owner acquired the property before 1 April 2001, there is an option of taking the actual cost of acquisition or fair market value as of 1 April 2001 for calculating the indexed cost of the property.

You can read about how to save capital gains tax here.

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