Tax filing on Capital Gains
Tax filing on Capital Gains
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Tax filing on Capital Gains

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

Updated on: 20 Jun, 2024 12:11 PM

If you have inherited a property from your forefathers and want to know about its taxation, then you are at the right place. All the properties inherited from father, grandfather, and great-grandfather are considered inherited properties. However, there are some exceptions to this. The Income Tax Act provides various rules and regulations regarding the tax on sale of ancestral property. This article covers all that you need to know about inherited property and its taxation.

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.

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.

NRIs must file their income tax returns in India to

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.

NRIs must file their income tax returns in India to

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.

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
2019-20 289
2020-21 301
2021-22 317
2022-23 331
2023-24 348
  • 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

  • The aggregate holding period for inherited property is considered from the date of property purchase by the original owner and not from the date of inheritance.
  • Any major repairs, additions, or improvements in the property have to be adjusted while calculating the long-term capital gains. All the expenditure of capital nature incurred on the improvement of capital asset by the assessee on or after 1\04\2002. If incurred before 1\04\2002, then ignore.
  • If the property has been acquired by the original owner prior to 1 April 2001, you can use the actual cost of acquisition or fair market value as on 1 April 2001 for calculating the indexed cost of the property.

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 take get help from professional CAs who can provide you with end-to-end tax solutions catered to your needs.

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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?

The sale of inherited property is to be reported under the head of Capital Gain. The cost at which the previous owner acquired the property is taken as the cost of acquisition, and the actual sale amount is considered the sale proceeds. In the case of Long-term capital assets, the cost of acquisition is calculated with the benefit of indexation.

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

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

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

Yes, the sale of an 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 the sale of inherited property, one can invest in specified instruments such as purchasing 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 on sale of ancestral property. However, any income earned on the 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 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.