How to Calculate Capital Gains on Sale of Inherited Property?

Inherited property itself is not taxed when received, but capital gains tax may apply when you sell inherited property. The tax is calculated based on the previous owner’s cost of acquisition, holding period, and eligible indexation benefits. You may also reduce or save tax through exemptions such as Section 54 and Section 54EC.

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. 

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 long-term capital gains tax rate on sale of property is 12.5% without indexation. However, if the property was bought before 23rd July 2024 then the taxpayer can opt for LTCG tax at 20% with indexation benefit if it is beneficial. 

Short-term capital gains arising as a result of transfer of a property are taxed at applicable tax slab rates. 

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 2024-25 is 363.

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.80 lakh. Neha inherited this property from her father in 2012. However, she decided to sell the house. In May 2024, Neha sold this house for Rs.2.75 crore.

In this case, the cost for calculating Neha’s capital gain shall be Rs.80 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. 

How to Save Capital Gains On Inherited Property?

1. Claim Exemption Under Section 54 of Income Tax Act: If you sell an inherited residential property and reinvest the capital gains in another residential house within the prescribed timeline, you may claim exemption under Section 54.
2. Invest in Capital Gains Bonds Under Section 54EC of Income Tax Act: You can save tax by investing up to the eligible limit in specified 54EC bonds (such as bonds issued by entities like National Highways Authority of India or Rural Electrification Corporation) within 6 months of sale.
3. Use the Cost Inflation Index (Indexation Benefit): For inherited property, the cost to the previous owner is considered, and indexation can help reduce taxable long-term capital gains.
4. Deposit Unused Gains in a Capital Gains Account Scheme (CGAS): If you need more time to reinvest before the ITR due date, park the amount in the Capital Gains Account Scheme and claim exemption, subject to conditions.
5. Deduct Eligible Transfer Expenses: Brokerage, legal fees, and transfer-related expenses incurred during sale can reduce taxable gains.
6. Plan Joint Reinvestment Carefully: If reinvesting in a new property, structure ownership and investment properly to maximize exemption eligibility.

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.