Capital Gains Tax on Sale of Inherited Property: How to Calculate It?
Updated: Nov 6
The taxes imposed on the sale of inherited property differ significantly from those imposed on the sale of property acquired through the usual acquisition process. When you inherit a property or other asset, you may be subject to estate tax, also referred to as inheritance tax. Regardless of the market value of the property you inherit, India does not impose inheritance tax under Section 56(ii) of the IT Act. However, capital gains will be taxed if you sell one of these inherited properties. How is the tax on inherited property determined when you decide to sell it? We will explain the process in this article.
Table of content
What is inherited Property?
Inherited property is the property that has been bequeathed or transferred to a deceased person's lawful heirs. Such property can be referred to as the legal heir's inheritance. A deceased person's mother, grandkids, children, spouse, and other family members may be considered their legal heirs. Personal legislation such as the Indian Succession Act 1925 and the Hindu Succession Act 1956 regulate property inheritance in India. Property may be passed down to legal heirs by will or the law of succession. A different method for someone to acquire property is through a gift deed that an immediate family member has executed.
What is Inheritance Tax?
Inheritance tax is the income tax liability in the hands of the beneficiaries if they obtain any assets through inheritance/will. However, in India, any money or property inherited or received through a will is exempt from taxes under section 56(2)(x). An individual may be liable for income tax as a consequence of their inheritance if they have to pay taxes on income from inherited property. The new owner of inherited property frequently receives additional revenue in the form of interest, rent, etc. The new proprietor therefore needs to report this extra income on income tax submissions and pay taxes on it.
How to Manage Inheritance
There are several ways to distribute and manage inheritance. Here are three standard methods:
Succession Will
An individual who has passed away (the testator) can designate the legitimate heirs to their property in a Will of Succession. The points that follow are important elements of this strategy:
Legally binding: It satisfies legal standards and is accepted by the law.
Executor: In accordance with the terms of the will, the testator usually designates an executor to oversee the estate distribution.
Flexibility: The individual who makes the will is allowed to hand over assets to friends, family, or charitable groups.
Probate Process: The will usually pass through a probate process, in which a judge checks its validity and supervises its distribution.
Nominative Inheritance
A person can designate a nominee to inherit particular assets through inheritance by nomination. This approach consists of:
Direct Transfer: The nominee takes legal possession of the asset upon the death of the asset holder.
Typical of Financial Products: Financial goods such as bank accounts, insurance plans, and retirement money are frequently handled using this technique.
Restricted Scope: Usually, this only pertains to particular assets and not the entire estate.
Legal Recognition: the legal entity that controls the asset must register and approve the nomination.
Joint Ownership Inheritance
Assets owned jointly by two or more people immediately go to the surviving owner or owners if one of them passes away. The method in question consists of:
Right of Survivorship: The surviving joint owner or owners are entitled to inherit the deceased's portion of the asset without going through probate.
Typical in the Real Estate Industry: This technique can often be applied to business ownership, bank accounts, and property ownership.
Taxation on Sale of Inherited Property
Upon the sale of the inherited property, the owner is responsible for paying the capital gains tax due. The amount of money gained from the sale of a succeeding item is not shielded from gift tax and is liable to capital gains tax, although any asset obtained as an inheritance is. Depending on how long the asset was owned, capital gains might be either short-term or long-term. The funds generated from the sale of an inherited property are considered as Long Term Capital Gains (LTCG) if the property was owned for a period of two years or more.
The holding period starts when the previous owner purchased or obtained the property to calculate capital gains on its sale. Therefore, an inherited property is usually subject to the LTCG tax. When inherited property is sold, the following are the capital gains:
Long-Term Capital Gains (LTCG) are gains from a property that are held for more than 24 months after the date of acquisition and are subject to a 20% indexation tax. However, the Budget 2024 reduces taxes.
Gains from the property that are held for less than 24 months from the date of acquisition are referred to as short-term capital gains (STCG) and are subject to the applicable slab rate for the taxpayer.
Steps to Calculate Capital Gains Tax on Inherited Property
The steps below outline how to determine the capital gains on inherited property:
Step 1: To figure out the capital gains, it is necessary to know the purchasing and indexing costs.
Step 2: Property Cost: Although the inheritor paid nothing for the property, the cost to the prior owner is taken into account when calculating capital gains. The F.M.V. as of April 1, 2001, or the actual expense, whichever is greater, can be considered the acquisition cost if the property had been purchased by the previous owner before to that date.
Step 3: Indexation Cost: The year of the original owner's purchase and the year of the property's sale is taken into account for indexing the acquisition cost.
Step 4: 2001 acts as the base year for these analyses.
Step 5: Use the following method to determine the cost of capital gains: Cost of acquisition x (Cost inflation index of the year of sale / Cost inflation index of the year of acquisition).
Specifications of the Cost Inflation Index (CII), which varies each fiscal year, can be accessed here. For the fiscal year 2023–2024, the Cost Inflation Index (CII) is 348. To find the net gain of the transaction, step six is to deduct the cost of capital gain from the property's sale price.
Illustration
Mr. X paid Rs. 75 lakh for a property on August 1, 2004. In 2012, Y acquired this property as an inheritance from her father. But she made the conscious choice to sell the house. Y sold this house in May 2023 for Rs. 3.00 crore. Y's capital gain in this instance will be calculated for Rs. 75 lakh, which will be indexed because it is a long-term capital gain. For indexation objectives, the 2004-05 CII will be considered for account. The following table illustrates how the capital gain will be calculated:
Particular | Amount |
Sale Consideration for the property | Rs. 3,00,00,000 |
Less : Indexed Cost of acquisition Rs. 75,00,000 * 348/113 (Rs. 75 lakhs * CII Index of 2023-24/ CII Index of 2004-05 ) | Rs. 2,30,97,345 |
Long term Capital gain (LTCG) | Rs. 69,02,655 |
Long term capital gain tax @20% | Rs. 13,80,531 |
The year or date of inheritance has no bearing on this computation. Notably, the indexation benefits that were previously provided on the sale of long-term assets have been removed, commencing FY 2024–2025. Taxpayers now have the choice to calculate taxes at 12.5% without indexation or 20% with indexation on real estate transactions acquired before July 23, 2024, according to the government.
Tax Savings on Capital Gains on Inherited Property
The following strategies can help taxpayers avoid paying capital gains tax when selling inherited property:
Section 54 Exemption: Using the sale proceeds to construct a new home within three years or to purchase a new home before the sale or within two years of the inherited property's sale date. A taxpayer is permitted to purchase up to two residential properties, and they are free from the LTCG up to Rs. 2 crore. Furthermore, according to the Finance Act of 2023, an application for exemption from FY 2023–2024 may not exceed an overall threshold of Rs 10 Cr.
Section 54EC Bonds: Within six months of selling an inherited property, invest the sale revenue in bonds that are issued by the National Highway Authority of India (NHAI), Indian Railways Finance Corporation Limited (IRFC), Rural Electrification Corporation Ltd (RECL), and Power Finance Corporation Ltd (PFC). However, in a fiscal year, the maximum amount of an eligible investment that is excluded from capital gains tax is Rs.50 lakh.
Any authorised bank, except certain rural branches, may invest the proceeds from the sale of inherited property in a "Capital Gains Account" by the Capital Gains Account Scheme, 1988. Additionally, be certain that the sum of money lined up is used up within three years of the transfer. Otherwise, it will be deemed a long-term capital gain as of the end of the three years.
Budget 2024 Updates
The indexation benefit was previously eliminated by the government when selling real estate. However, this rule was tossed back with the Finance Bill 2024 amendment. According to the most recent modification, taxpayers will have the choice of two LTCG calculating techniques for any immovable property purchased prior to July 23, 2024:
12.5% tax rate in the absence of indexation
20% tax rate with the benefit of indexation.
The taxpayers can use either of these procedures to calculate their taxes and choose the one that lowers their tax liability. In other words, if taxpayers choose to pay taxes at 20%, they can take advantage of indexation. By selecting a different way of tax computation, they will also have the chance to save money.
Nevertheless, this amendment has some limitations. The indexation benefit is limited to immovable property, such as buildings and land. Firms or companies are unable to utilise it; only individuals and HUFs can. It is solely applicable to tax computations; it does not apply to figuring out how much money should be invested or lost in order to qualify for an exemption or carryover.
Long-term capital gains: The yearly LTCG deduction has been increased from Rs. 1 lakh to Rs. 1.25 lakhs. All assets, whether financial or non-financial, now have an LTCG rate of 12.5%.
Short-term capital gains: A 20% STCG tax will be applied to specific financial assets. The appropriate slab rates will be utilised to tax STCG on other non-financial assets.
However, regardless of holding term, unlisted bonds and debentures, debt mutual funds, and market-linked debentures will be subject to capital gains tax at the appropriate rates. You can speak with expert tax consultants to learn more about it.
Conclusion
Paying the right taxes should be simpler for you now that you understand how the tax is determined when inherited property is sold. Property tax status monitoring and payments can now be conducted online with convenience. To learn more about your possibilities, speak with a professional if you want to purchase capital gain bonds to reduce taxes on the sale of inherited property. You can acquire a loan from the bank even if you intend to buy or build a home to qualify for LTCG exemption.
FAQ
Q1. What is the capital gains tax on inherited property in India?
When inherited property is sold, the following are the capital gains: Gains from the property are generally referred to as Long-Term Capital Gains (LTCG) and are assessed a 20% indexation tax as long as they are kept for more than 24 months on the date of acquisition. Budget 2024, however, lowers taxes.
Q2. What is the difference between ancestral property and inherited property?
Inherited property is any asset that is transferred or inherited following the death of the antecedent through a will. Ancestral properties are those that have been passed down from the parent.
Q3. Who is the owner of a property in India after husband’s death?
According to Hindu law, a wife inherits an equal portion of her husband's estate, which is subsequently divided among the mother, children, and other Class I heirs. This only comes into play if the male passes away intestate. The wife has the right to the whole property if there are no children or other applicants.
Q4. Does a daughter have a rightful share in her father’s property?
The Supreme Court modified the Hindu Succession Act in 2005, granting girls the same property rights as their sons. This act guarantees daughters the birthright to their fathers' or their ancestors' property.
Q5. How to transfer a property from father to son?
In India, transferring property from father to son through a gift deed begins with the creation of a gift deed, which is a written statement of the father's (donor) intention to give the property to his son (donee). It also includes information about the parties and a declaration of voluntary transfer without consideration.
Q6. Are all inherited properties tax-free?
Yes, there is no tax on any property inherited from one's immediate paternal ancestors.
Q7. Who needs to pay tax on the inherited property and when?
If the inheritor sells the ancestral property, they will be bound to pay taxes on the capital gains.
Q8. How is tax liability calculated on ancestral property?
Ancestral property that has been inherited is subject to taxes upon sale. This kind of sale results in a capital gain and the period of holding is determined starting on the original owner's purchase date by the capital gain computation.
Q9. How do I show the sale of inherited property on my tax return?
Inherited property sales must be reported under the capital gain heading. The genuine sale price is considered as the sale earnings, while the price paid by the previous owner in order to purchase the property is recognised as the acquisition cost. The advantage of indexation is used to assess the acquisition cost of long-term capital assets.
Q10. Do I have to pay taxes on the sale of the home of my deceased parents?
A person's property would be transferred to his legal heirs upon his death, and only the legal heir would benefit from any capital gains on inherited property or losses from a sale. As a consequence, the legal heir will pay taxes.
Q11. Is the sale of an inherited house considered income?
Yes, the sale of a residence that was inherited is subject to income tax under the capital gains heading.
Q12. How can I avoid paying taxes on inherited property?
One can invest in specific instruments, such as buying a residential home or NHAI/REC Bonds, among others, to reduce taxes on the sale of inherited property.
Q13. Do beneficiaries have to pay taxes on inheritance?
The selling of ancestral property in India is excluded from income tax. Any earnings received from the inherited assets' future investment, however, will be covered by taxes.
Q14. What did Budget 2024 propose in regard to the removal of indexation benefits for properties?
Indexation benefits on capital gains from the sale of long-term capital assets are to be eliminated, according to the Budget 2024. In the past, real estate investors lowered their taxable earnings by incorporating inflation in their purchase costs. Both financial and non-financial assets now have a 12.5% long-term capital gains tax rate instead of 20%. The indexation’s advantage for long-term sale of assets has been removed, though. Any sale of long-term assets made after July 23, 2024, will therefore be subject to 12.5% taxation without the indexation benefit. Assets bought on or before April 1, 2001, can still be sold by individuals using the fair market value (FMV) as the cost of acquisition.
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