There is considerable confusion about the Capital gains tax levied on the sale of inherited property. While many think that the money received on sale of inherited property is completely tax-free, others believe it is fully taxable.
In fact, there is no tax liability at the incidence of inheritance. However, profits from the sale of inherited property are taxable as capital gains.
How to calculate Capital Gains on Sale of Inherited Property
A capital gain may be short-term or long-term, depending on the period over which the asset was held. If the inherited property is held for more than 36 months, it is treated as a long-term asset. This 36-month period includes not only the period you held the house but also the period it was held by the prior owner/s who had paid for it.
For a holding period of fewer than 36 months, the actual cost of acquisition and any costs of the improvement will be deducted, and the balance will be treated as short-term gains and taxed at the minimum tax applicable to you. If the combined holding period exceeds 36 months, you will be entitled to deduct the cost of acquisition and cost of the improvement, which will be increased by the cost inflation index multiplier. The cost inflation multiplier is calculated on the basis of the cost inflation index of the purchase year and the year of sale.
The acquisition cost is the amount paid by one of the previous owners for the purchase of the house. For example, consider a scenario in which you inherited a house from your father, and he inherited it from his father. If your grandfather bought the house for 50,000 rupees, your cost of acquisition for capital gain would be Rs 50,000. If the house was inherited before 1st April 1981, you can also replace the fair market value of the assets as on 1st April 1981 by the ‘cost of acquisition’ and implement the cost inflation index multiplier on that value.
In case the asset is inherited by you after 1 April 1981, you will need to consider Rs 50,000 as acquisition cost. After reading the income tax rules carefully, you can claim the benefit of indexation concerning the year in which you inherited the property only and not earlier. However, high courts in Mumbai, Delhi, and Gujarat believe that if the asset is acquired after 1 April 1981, the taxpayer can claim indexation benefits from the year the previous owner who had paid for it had obtained it.
Even if the property was purchased before 1st April 1981, you can substitute the cost of the asset on 1st April 1981 for the cost of acquisition and receive the indexation benefits from 1st April 1981, even if you later inherited it.
Exemption from long-term capital gains
For a long-term asset, you have two ways to save taxes. You can either invest the capital gains to buy a home within two years or build a home within three years. Alternatively, you can invest in capital gains of up to Rs 50 lakhs in bonds issued of REC or NHAI within six months of its accrual.