Summary of this article
Holding period errors can sharply increase property tax
Indexation misuse often leads to higher tax liability
Correct timing can save lakhs in capital gains tax
When it comes to transactions related to property in India, capital gains tax is where most sellers lose money, because the rules and guidelines are often misunderstood. Every time any individual sells a real-estate based asset like a plot of land or a house, the Income Tax Department looks at two things: how long the seller has possessed the property and how has he or she calculated the capital gains. If you get either of the two wrong, your tax liability shoots up.
For property, the distinction between short-term and long-term capital gains is clear. If you sell a property within 24 months of buying or inheriting it, the profit is treated as a short-term capital gain (STCG) and taxed at your applicable tax slab. If you sell it anytime after 24 months, it is viewed as a long-term capital gain (LTCG) and is taxed at 20 per cent with indexation benefits. This single difference can result in a higher taxation. However, in 2024, the rules regarding taxation changed. Following the change, the indexation benefit is available for the sale of a flat, but only if you bought it before July 23, 2024. Additionally, for properties sold after July 23, 2024, taxpayers also have the option to pay 12.5 per cent tax without indexation.
Indexation benefits are meant to ensure that property sellers are taxed for the real gains and not on the total selling price caused by inflation. When a property is sold after being held on a long-term basis, the original purchase cost is adjusted using the government’s Cost Inflation Index, which reduces the taxable capital gain. A crucial aspect of indexation is that it is calculated from the financial year in which legal ownership is registered, not the booking or the payment year. Often people confuse these two dates and expose themselves to tax disputes.
Misunderstanding About Indexation
Indexation is a commonly misunderstood concept in calculating capital gains tax on property. Many buyers believe that indexation starts from the year they paid for the property. However, that is incorrect.
Indexation begins from the year the property is legally acquired, not when the booking is done or when the instalments start. In most cases, this means the year of possession or registration, whichever can be used as proof for ownership rights. For under-construction properties, this misunderstanding can alone inflate the indexed cost and lead to disputes in taxation.
Hardeep Singh Panesar, Founder, Investment Wizard Pvt Ltd, says, “The most common misunderstanding around indexation is the assumption that it inflates the property’s market value. In reality, indexation applies only to the original acquisition cost, adjusted using the government-notified Cost Inflation Index for the year of purchase and sale. It does not reflect renovation value unless supported by valid, documented capital improvement costs.”
Indexation does not mean it erases gains; it just adjusts your purchase cost for inflation using the government’s Cost Inflation Index.
How sellers unintentionally trigger short-term capital gains
The most common error is the miscalculation of the holding period; many sellers count from the agreement date or the first instalment. Tax law does not take into account intentions or payment schedules. It takes into account who actually owned the property and the time period in which it was owned; that’s when proof of legal ownership comes into play. Selling even a few days before completing the 24 month time period can lead to the imposition of STCG instead of LTCG.
Inherited properties can create another trap; sellers sometimes assume their own holding period starts from the inheritance date. When in reality, the previous owner’s holding period is carried forward, but that is only if the documentation is clear.
This can not be fixed later; once the sale deed is executed, the nature of the gain is locked. You cannot reverse the STCG to LTCG through any kind of explanations or documents. Capital gains planning must be thought through before the sale happens, not after.
“For inherited or gifted property, the most effective and legally safe way to minimise tax is to use the original owner’s purchase cost and holding period, combined with reinvestment in another residential property or specified bonds, as permitted under the Income Tax Act”, adds Panesar.
Here’s how much your tax burden can change depending on the imposition of LTCG and STCG tax. Let’s assume an individual ‘A’ who’s income is in the 30 per cent tax bracket bought a property for Rs 50 lakh in May 2021. Assuming he sells the property for Rs 90 lakh he will gain Rs 40 lakh.
STCG Taxation
If the flat is sold before the completion of the 24 month period, the Rs 40 lakh gain will be taxed at the 30 per cent slab rate and will be treated as a part of his income. Resulting in a STCG tax outgo of Rs 12 lakh.
STCG Tax = Gains x 30/100
LTCG Taxation With Indexation
If the flat is sold after the completion of the 24 month period in August 2024, the capital gains will be calculated on the basis of the inflation adjusted purchase price. The indexed cost will be calculated by multiplying the cost of acquisition with the Cost Inflation Index (CII) for the purchase year divided by the Cost Inflation Index (CII) for the selling year. Notably, the CII number for 2021-22 was 317 and the CII number for 2024-25 was 363. Thus the indexed cost will be:
Indexed Cost Calculation = Rs 50,00,000 x 363 / 317 = Rs 57,25,552
Thus the taxable profit will be calculated by deducting the indexed cost from the total selling price (Rs 90,00,000 - Rs 57,25,552 = Rs 32,74,448). Thus the inflation adjusted profit will be taxed at 20 per cent, resulting in a LTCG tax outgo of Rs 6,54,890.
LTCG Without Indexation
Assuming ‘A’ chooses the new 12.5 per cent tax rate, his capital gains of Rs 40 lakh will be simply multiplied by 12.5 per cent, resulting in a LTCG tax outgo of Rs 5,00,000.
LTCG Tax = Gains x 12.5/100
To conclude, investors who sell their properties should be mindful of the taxation on their gains and the overall rules regarding indexation which can increase or decrease the actual returns they make from their investment.
