You might be have been recently or earlier bequeathed a property that you do not know how to use fruitfully. The best decision that comes to your mind is to sell it. However, the sale of inherited property entails certain procedures.
Did you know that the income tax provisions for the sale of inherited property and its capital gain is different from that of a property obtained through other means? Many people think that the sale of an inherited house is fully tax exempted. However, this is a false notion.
This article will help you understand the process and the legalities involved. We hope that it gives you a better picture and clarity on how to proceed with the sale of such property. Learn how to make a smart decision and save on the taxes involved in its sale.
Inherited Property – The Tax Scenario
In India, the inheritance tax was officially abolished in 1986. There have been arguments and discussions on reintroducing it to tackle the issue of vast wealth disparity. Let us look at the current status for computing tax on the sale of any inherited property. This property is taxable when it is sold to someone by the inheritor. The income received from such a transaction is classified as long-term capital gain.
Long Term Capital Gain (LTCG) – A Brief Introduction
Capital gain is the profit obtained from short and long-term assets including property, gold, shares, etc. any asset is termed as ‘long-term’ if it has been in your possession for over 2 years. So, if you have inherited property before 2 years, or even if the original buyer had it for that period, it comes under LTCG.
LTCG encompasses all income arising from the profits through the sale of assets in the name of the owner, in possession for a significant period of time. The assets include immovable property, real estate, shares, and equities. Until last year, the minimum possession period of asset inviting taxes was 3 years, which has been reduced to 2 years now. The tax rate for sale of an asset is fixed at 20% of the profit received.
Keep in mind that the year of inheritance does not have any bearing on the tax computation. The profit is calculated by simply deducting the purchase price of the property from the consideration value at which it was disposed.
The Cost Inflation Index (CII) is essential for calculating the tax. It is notified during every year’s budget announcement. Refer to this table for making your calculations:
Consider this example of tax calculation for inherited property:
Year of Purchase: 2001
Year of Inheritance: 2011
Year of Sale: 2018
Purchase Price: 5,00,000 (5 lakhs)
Sale Price/Consideration Value: INR 30,00,000 (30 lakhs)
Purchase Price Index Factor: 280/100 = 2.8
Indexed Value of Purchase Cost: 2.8 x 5,00,000 = 14,00,000 (14 lakhs)
Profit: 30,00,000 (Consideration Value) – 14,00,000 (Indexed Value) = 16,00,000 (16 lakhs)
Tax (20% of Profit) = 3,20,000 (3.2 lakhs)
It must be noted that any sale transaction that is lesser than the indexed value will not entitle any taxation.
Avoiding or Reducing Tax on Inherited Property
As you might see from the calculation, the tax for sale of inherited property is substantial. There is a possibility to avoid paying this tax, without indulging in any illegal means. For this, you will need to invoke the provisions of Section 54EC of the Income Tax Act of 1961. Based on the provisions, public organizations like Rural Electrification Corporation and National Highways Authorities can issue authorized capital gains or infrastructure bonds. These bonds are specifically meant for LTCG. Any investment you make in them goes into public expenditure for national growth. As a result, they are completely exempted from taxes to the extent of 50 lakhs.
Typically, infrastructure bonds have a duration of 5, 10 or 15 years. These bonds are tradable on the stock exchange. The returns you receive from them range from 5 to 7%. The interest received is taxable during the year of accrual as income in the respective tax slab. The redemption value is also taxable but in the form of LTCG. The taxes are nil since these bonds are redeemed at face value. The LTCG provision applies only when the bond is prematurely sold at a premium. Even in this scenario, the tax you have to pay is minimal.
Using the example above, let us make further calculations:
Tax Liability on Inherited Property –3,20,000
The amount is invested in Infrastructure bonds at 6% Interest for 5 Years.
The annual income is INR 19200/year for 5 years
With a 30% tax slab, your net annual income works out to: (19200 – 5760) = 13,440
Net income in 5 years = 67,200
At the end of 5 years, after you redeem the value of the infrastructure bonds, the value erosion will be only the result of inflation. The cash flow can tolerate an indexation factor of approximately 80%.
(3,20,000/3,87,200) = 0.82
Even though the calculations are simplistic, the other factors like interest on annual cash flow are unlikely to make a substantial difference. It is never easy to predict inflation or estimate indexation value of a future date. However, going by the current trend, these values are positive and there is no reason to worry about mishaps in the future. You can choose to prematurely dispose of the bonds if you are concerned about inflation.
In simple terms, through this method of investment, you lose a small amount after 5 years instead of shelling out a lump sum amount of 3,20,000 today.
More Tax-Saving Schemes
You can also save taxes on LTCG if you use the profit from the sale of a property to buy or construct a house within 2 years. You can deposit the sales proceedings in a bank with the assurance that it will be invested on legal provisions stipulated by bank rules. Only if you default on this account will the bank deduct tax on LTCG.