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How to calculate Capital Gains on Sale of Inherited Property

Updated on: May 31st, 2023

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10 min read

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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.

What is inherited property?

The property passed down or transferred to the legal heirs of a deceased person is called as 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 an inheritance tax?

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. However, an owner of inherited property is liable to pay the annual tax under the head 'Income from house property'. The annual value is considered nil for self-occupied property, whereas, for a let-out property, the annual amount is the yearly rent received.

Taxation on selling an 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 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 is 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 will beign from the time when 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 20.8% (including cess) with indexation.
  • When the property is held for less than 24 months from the date of acquisition, the gains from the property will be termed as Short Term Capital Gains. (STCG) and is taxed at the slab rate applicable to the taxpayer.

Procedure to calculate the 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. 

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 has been updated from 1981 to 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 a few are tabulated below:

YearCIIYearCII
2001-021002011-12184
2002-031052012-13200
2003-041092013-14220
2004-051132014-15240
2005-061172015-16254
2006-071222016-17264
2007-081292017-18272
2008-091372018-19280
2009-101482019-20289
2010-111672020-21301

The Cost Inflation Index (CII) for the financial year 2022-23 is 331.

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 decides to sell this house. In May 2014, Neha sold this house for Rs.1.8 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. 

Therefore, the cost for calculating capital gains for Neha shall be 

Rs.75 lakh x CII of 2014-15 / CII of 2004-05 
= Rs.75 lakh x 240 / 113 
= Rs.1.6 crore.

Therefore, the net gain for Neha is Rs.20 lakh (Rs. 1.8 crore-1.6 crore). 

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

How to save capital gains on inherited property?

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

  • Investing the sale proceeds in bonds of the Rural Electrification Corporation Ltd (REC), National Highway Authority of India (NHAI), Indian Railways Finance Corporation Limited (IRFC) and Power Finance Corporation Ltd (PFC) within six months from the sale of inherited property. However, the maximum eligible investment amount exempt from capital gains tax is Rs.50 lakh in a financial year.
  • 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.
  • 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 two years, else the deposited sum will be treated as a short-term capital gain from the day two 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.
  • While calculating long-term capital gains, any amount spent on repairs, addition or improvement in the property needs to be adjusted.
  • If the original owner has acquired the property before 1 April 2001, there is an option of taking the actual cost of acquisition or fair market value as on 1 April 2001 for calculating the indexed cost of the property.

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

Related Articles

Capital Gains Tax on Sale of Land

Capital gain tax on sale of property/Shares/Jewellery

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