How to Calculate Capital Gains on Sale of Inherited Property?

What is Ancestral/Inherited Property?

Any property that a person inherits from any of the three mentioned immediate paternal ancestors:

• Father
• Grandfather
• Great Grandfather

is called ancestral property.

Any property inherited from a person apart from the above-mentioned list is not considered ancestral property according to the Income Tax Act 1961.

Even any property inherited from the maternal ancestors is also not considered ancestral property.

Until 2005, only male members could inherit ancestral property, but the amendment in 2005 states that even females have equal rights over it.

What is an Inheritance Tax in India?

An inheritance tax is a tax on the sale of inherited property. It is imposed on the income generated from ancestral property by an individual. When someone passes away, their properties transfer to their legal heirs, such as children, grandchildren, or wards. Often, the inherited property serves as a source of income, such as rent or interest, for the new owner. Consequently, the new owner is responsible for declaring this income and paying the applicable taxes. Inheritance tax applies to any assets or property transferred by a deceased individual to their legal heirs, whether children or grandchildren.

Methods of Inheritance Tax

Inheritance can be managed and distributed through various methods. Here are three traditional ways:

1. Will of Succession
A Will of Succession is a legal document wherein the deceased person (testator) declares the lawful owners of their assets after their death. This method includes the following key points:

• Legally Binding: It is recognized by law and must meet legal requirements to be valid.
• Executor: The testator typically appoints an executor to manage the estate distribution according to the will.
• Flexibility: The testator can allocate assets to anyone they choose, including family members, friends, or charities.
• Probate Process: The will generally goes through a probate process, where a court verifies its authenticity and oversees the distribution.

2. Inheritance by Nomination
Inheritance by nomination allows an individual to name a nominee to inherit specific assets. This method includes:

• Direct Transfer: Upon the death of the asset holder, the nominee becomes the lawful owner.
• Common in Financial Products: This method is often used for financial products like bank accounts, insurance policies, and retirement funds.
• Limited Scope: Typically, this applies to specific assets rather than the entire estate.
• Legal Recognition: The nomination must be registered and recognized by the institution holding the asset.

3. Inheritance by Joint Ownership
In the case of joint ownership, assets held jointly by two or more individuals automatically pass to the surviving owner(s) upon the death of one owner. This method includes:

• Right of Survivorship: The surviving joint owner(s) inherit the deceased's share of the asset without the need for probate.
• Common in Real Estate: This method is often used for property, bank accounts, and business ownership.
• Simplifies Transfer: It ensures a smooth transition of asset management and ownership.
• Equal Ownership: Joint owners typically have equal rights to the asset unless specified otherwise.

Taxation of Ancestral Property Under the Hindu Succession Act

For taxation purposes, only the above-mentioned ancestral properties are to be taken into consideration.

Any property that is inherited from ancestors by the individual does not have any tax liability at the time of inheritance, regardless of its type (movable or immovable). This applies to both individuals and Hindu Undivided Families (HUFs).

However, when the inheritor sells out the inherited property, the capital gains earned on the sale of the property will be taxable.

Taxation on Selling an Inherited Property

The tax liability of the sold-out ancestral property depends on the capital gains tax on inherited property and its norms.

When the property is held for a period of more than 24 months from the date of acquisition, the gains from the property will be termed long-term capital gains. (LTCG). This capital gain on the sale of ancestral property is taxed at 20.8% (including cess) with indexation.

When the property is held for a period of less than 24 months from the date of acquisition, the gains from the property will be termed short-term capital gains. (STCG). This capital gain on inherited property is taxed at the slab rate applicable to the assessee.

Selling an inherited property? You may have to pay capital gains tax on the profit you make. The tax rate and calculation depend on various factors, such as the cost of the property, the date of acquisition, and the expenses incurred. Don’t worry; getting professional help can help you figure out the best way to save tax on your sale and file your ITR smoothly and within time.

LTCG and STCG Rates in 2023-24 and 2024-25 - Comparison

Budget 2024, announced on 23rd July 2024, brought about certain changes in the long-term and short-term capital gains tax rates and holding periods. Given below is a table showing the comparison between the capital gains tax rates in FY 23-24 and FY 24-25.

Taxation for mutual funds

Calculation of Capital Gains on Sale of Inherited Property

As we have discussed earlier, when a property is inherited or received as a gift, it is not taxable for the receiver.

But when the inheritor sells it, capital gains on the sale are taxable for the inheritor.

The procedure to calculate the capital gains of the inherited property is as follows:

• Step 1: The inheritor must know the cost of acquisition and the cost of indexation for the purpose of calculating capital gains.
• Step 2: Cost of the property – The cost of the property for the previous owner will be considered as the cost of acquisition of the property for the purpose of capital gains, as the property did not cost anything to the inheritor.
• Step 3: Indexation of cost – For the purpose of indexation, the year of acquisition for the previous owner will be considered along with the year of sale of the property.
• Step 4: The base year for the calculations has been updated from 1981 to 2001.
• Step 5: Calculate the cost of capital gains by using the formula for its calculation.

Where Cost Inflation Index (CII) varies every financial year. Some are mentioned below:

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

For example –

Mr. X purchased a property on 1 August 2004 for Rs.75 lakh. Y inherited this property from his father in 2012. However, he decides to sell this house. In May 2014, he sold this house for Rs.1.8 crore. In this case, the cost for calculating his 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 him 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 Y is Rs.20 lakh.

Note: The date or year of inheritance is of no importance in this calculation.

How to Save Capital Gains on Inherited Property?

Here are some options to minimize capital gains tax on inherited property when selling inherited property in India:

Invest in Specified Bonds:

• Purchase bonds issued by REC, NHAI, IRFC, or PFC within six months of the sale.
• Maximum exemption: Rs. 50 lakh per financial year.

Note: This option may not be ideal for large gains exceeding the limit.

Purchase or Build a New House:

• Invest the sale proceeds in constructing a new home within three years.
• Alternatively, buy a new residential property within one year before or two years after the sale.
• Maximum exemption: Rs. 2 crore for up to two properties.
• This option might require significant investment and may not suit everyone's needs.

Capital Gains Account Scheme:

• Deposit the sale proceeds in a designated "Capital Gains Account" within authorized banks.
• Utilize the deposited amount within two years to invest in a new residential property or for infrastructure development bonds.
• Failure to utilize the amount within two years leads to short-term capital gain taxation.

Capital gains must be reported in the ITR while filing your taxes. Not just this but, there are various ways to save taxes on your capital gains. Therefore, it is important to get help from professional CAs who can provide you with end-to-end tax solutions catered to your needs.