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How to Calculate Income Tax & Captial Gains on Sale of Inherited Property?

Updated on: 30 Mar, 2022 03:56 PM

Properties that are inherited up to four generations of male lineage that is father, grandfather, and so on is called as ancestral property. However the income tax act does not consider all the inherited assets as ancestral property. The various regulations that are stated in income tax act regarding the tax liability of the ancestral property is covered in this article.

Concept of ancestral property

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

  • Father
  • Grandfather
  • Great Grandfather

is called as ancestral property.

Any property inherited from a person apart from the above mentioned list is not considered as ancestral property according to the income tax act 1961.
Even any property inherited from the maternal ancestors is also not considered as ancestral property.
Until 2005, only male members can inherit ancestral property, but the amendment in 2005 states that even females have equal rights over it.


Taxation of ancestral property under the Hindu Succession Act

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

At first instance, any property that is inherited from ancestors by the individual does not have any tax liability at the time of inheritance. No tax is levied on that at present.
However, as and when the inheritor sells out the inherited property, the capital gains that are earned on the sale of the property will be taxable.


Tax liability of the sold-out ancestral property

The tax liability of the sold-out ancestral property depends on the capital gains 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 as long term capital gains. (LTCG). This capital gain 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 as short term capital gains. (STCG). This capital gain is taxed at the slab rate applicable to the assessee.

Calculation of Capital Gains on Sale of Inherited Property

As we have discussed earlier that 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 calculation of 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,

Cost of acquisition x Cost Inflation Index of the year of acquisition/(divided) Cost Inflation Index of the year of the sale

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

Year  Cost Inflation Index (CII)
2001-02 100
2002-03 105
2003-04 109
2004-05 113
2005-06 117
2006-07 122
2007-08 129
2008-09 137
2009-10 148
2010-11 167
2011-12 184
2012-13 200
2013-14 220
2014-15 240
2015-16 254
2016-17 264
2017-18 272
2018-19 280

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.


Points to be noted

  • In the case of inherited property, the aggregate period of holding the property is counted from the date of purchase of the property by the original owner and not from the date it is inherited by the seller.
  • While the calculation of long term capital gains, any major repairs, addition or improvement in the property needs to be adjusted.
  • If the property has been acquired by the original owner prior to 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.

Tax benefit

The major tax benefit on inherited property is one can claim tax exemption on the gains that are made from the sale of the same property.

For this there are three options available:

  • The first option is it can be done by reinvesting the gains in another property. This can be claimed when the long term capital gains are less than Rs. 2 crores and the reinvestment is done only in a maximum of two residential properties located in India.
    If gains are more than Rs. 2 crores the inheritor can reinvest in one property to claim the exemption of tax.
    These investments are to be made within the specified time limits that are one year prior to the sale or two years from the sale or within three years for an under-construction property.
  • The second option is to use the amount of gains to construct a house within three years from the sale of the ancestral property.
  • The third option is to invest the amount of gains in capital gains bonds under Section 54EC of the Income-tax Act, 1961 . The total investment limit that is specified in these bonds is restricted to Rs. 50 lakh per Financial Year.

Conclusion

As discussed inherited properties are not levied any tax when inherited by the heir. But as and when he or she sells out the property he or she is bound to pay tax on it. There are few rules with which he or she can claim the exemption as per the case may be.


Frequently Asked Questions

Q- Are all inherited properties tax-free?

Yes, all the properties that are inherited from the immediate paternal ancestors are free from tax.


Q- Who needs to pay tax on the inherited property and when?

The inheritor needs to pay tax on capital gains from the ancestral property if he or she sells it out.


Q- How is the tax liability calculated on the ancestral property?

The tax liability on the ancestral property is calculated as per the regulations of long term and short term capital gains.


Q- How do I report the sale of inherited property on tax return?

Sale of inherited property is to be reported under the head of Capital Gain. Cost of previous owner is the cost of acquisition and Sale proceeds are taken as sale amount. The Cost of Acquisition is subject to benefit of indexation in case of Long Term Capital Asset (LTCA).


Q- Do I have to pay taxes on the sale of my deceased parents home?

In the event of death of an individual, properties belonging to the deceased would pass on to his legal heirs and the capital gain or loss in case of sale will accrue to legal heir only. Thus, tax payment will be done by legal heir.


Q- Is the sale of an inherited house considered income?

Yes, the sale of inherited house is taxable as Income under the head Capital Gain


Q- How can I avoid paying taxes on inherited property?

To save taxes on sale of inherited property , one can invest in specified instruments such as purchase a residential house property or NHAI/REC Bonds,etc.


Q- Do beneficiaries have to pay taxes on inheritance?

In India, there is no income tax levied on inheritance. However, any income earned on subsequent investment of the inherited assets shall be taxable.


CA Abhishek Soni
CA Abhishek Soni

Abhishek Soni is a Chartered Accountant by profession & entrepreneur by passion. He is the co-founder & CEO of Tax2Win.in. Tax2win is amongst the top 25 emerging startups of Asia and authorized ERI by the Income Tax Department. In the past, he worked in EY and comes with wide industry experience from telecom, retail to manufacturing to entertainment where he has handled various national and international assignments.