How to Calculate Capital Gains Tax on Sale of Inherited Property

Selling an inherited property can be both emotionally and financially significant. While you may not have paid for the property, the tax implications on the sale of inherited property can still be significant. Understanding how capital gains tax applies to such transactions is crucial to avoid any surprises when filing your tax return.

In this blog, we will guide you through the process of calculating capital gains tax on the sale of an inherited property, the exemptions available, and how to minimize the tax burden.

Understanding Capital Gains Tax on Inherited Property

When you inherit a property, you do not pay tax on its acquisition. However, if you sell that inherited property, the tax treatment differs from regular property sales. The capital gains tax on the sale of inherited property is classified as long-term capital gains (LTCG), regardless of how long you hold the property before selling it. This is because, for tax purposes, the property is considered to be held for a long-term period (i.e., more than 36 months in India).

However, the tax calculation can be complex and depends on several factors like the fair market value (FMV) of the property at the time of inheritance, the sale price, and any expenses related to the sale.

Step-by-Step Guide to Calculating Capital Gains Tax on Inherited Property

1. Determine the Sale Price of the Property

The first step in calculating capital gains tax is determining the sale price or sale consideration. This is the amount for which you sell the inherited property.

Example:

• If you sell the property for ₹50 lakh, the sale price is ₹50 lakh.

2. Calculate the Cost of Acquisition

The cost of acquisition refers to the price at which the inherited property is deemed to have been acquired by you. Since you didn’t buy the property, the cost of acquisition is based on the Fair Market Value (FMV) of the property on the date of inheritance. The FMV is determined based on the market value of the property at the time you inherited it.

• FMV Date of Inheritance: The date on which the original owner of the property passed away.

• If the FMV is not easily available, you can get it determined by a registered valuer.

Important Considerations:

• The FMV is considered the cost of acquisition for the purpose of calculating capital gains tax.

• If the property was inherited before April 1, 2001, and you don’t have the FMV, you can use the property’s fair market value as of April 1, 2001 as the cost of acquisition, if it was part of the estate that was inherited. This rule is intended to provide relief in case the property has appreciated substantially over time.

3. Adjust for Improvement Cost (If Any)

If you have incurred any costs for improvement (e.g., renovation or repairs) on the inherited property after it was acquired, these costs can be added to the cost of acquisition to reduce your taxable capital gains.

The improvement cost should be supported by receipts and proper documentation. These improvements could include structural changes, adding amenities, etc.

Example:

• Let’s say you spent ₹10 lakh on renovating the inherited property after its acquisition.

4. Calculate the Capital Gains

Now, the capital gains are calculated by subtracting the total cost of acquisition (FMV + improvements) from the sale price. The formula is:

Capital Gains = Sale Price - (Cost of Acquisition + Cost of Improvement)

Example:

• Sale Price: ₹50 lakh

• FMV on Inheritance: ₹30 lakh

• Improvement Cost: ₹10 lakh

• Capital Gains = ₹50 lakh - (₹30 lakh + ₹10 lakh) = ₹10 lakh

5. Apply Indexation (if applicable)

Since the property was inherited, indexation benefits are available to adjust the cost of acquisition and improvement for inflation over time. This helps reduce the capital gains tax by increasing the cost basis.

Indexation is based on the Cost Inflation Index (CII), which is published annually by the Indian government.

The formula for indexed cost of acquisition is:

Indexed Cost of Acquisition = Cost of Acquisition × (CII of the year of sale / CII of the year of acquisition)

For example:

• If the FMV of the property at inheritance was ₹30 lakh and the CII for the year of inheritance (say 2001-02) is 100, and the CII for the year of sale (say 2024-25) is 350, the indexed cost of acquisition would be:

Indexed Cost of Acquisition = ₹30 lakh × (350 / 100) = ₹1.05 crore

This indexed cost will reduce your capital gains and, consequently, your capital gains tax liability.

6. Apply the Tax Rate

In India, the long-term capital gains (LTCG) tax rate for the sale of property is 20% with indexation benefits.

So, in our example, after applying indexation:

• Indexed Cost of Acquisition: ₹1.05 crore

• Sale Price: ₹50 lakh

• Capital Gains: ₹50 lakh - ₹1.05 crore = ₹–55 lakh (No Capital Gain)

• Capital Gains Tax: 0% (No Tax Liability)

7. Exemptions Under Section 54

If the inherited property is residential property, you may be eligible for an exemption under Section 54 of the Income Tax Act by reinvesting the capital gains into another residential property within 1 year before or 2 years after the sale.

The exemption can be claimed if you purchase a new residential property and invest the capital gains from the sale of the inherited property into that new property.

However, this exemption is applicable only on the capital gains portion (not the entire sale price).

Key Points to Remember:

1. FMV as the Cost of Acquisition: The FMV at the time of inheritance is considered the cost of acquisition for the purpose of calculating capital gains tax.

2. Long-Term Capital Gains Tax: Inherited properties are subject to LTCG tax, regardless of the holding period.

3. Indexation: You can avail of indexation benefits to reduce the taxable capital gains on inherited property.

4. Exemption under Section 54: You can claim an exemption under Section 54 by reinvesting the gains in a new residential property.

Conclusion

Selling inherited property can trigger capital gains tax, but by understanding how to calculate it—using the FMV, considering improvements, and applying indexation—you can significantly reduce your tax liability. Additionally, exemptions under Section 54 provide an opportunity to save taxes if the proceeds are used to purchase a new residential property.

If you are unsure about the valuation, tax implications, or exemptions available, it’s a good idea to consult a tax professional or financial advisor to help you navigate the process and optimize your tax strategy.

FAQs

1. Can I sell inherited property without paying tax? No, while you don’t pay tax on the inheritance itself, selling the property will trigger capital gains tax.

2. What is the cost of acquisition for inherited property? The cost of acquisition is the Fair Market Value (FMV) of the property at the time of inheritance.

3. Can I claim indexation for inherited property? Yes, indexation is available on the cost of acquisition and improvements, reducing your capital gains tax liability.

4. Is there any exemption for inherited property? Yes, exemptions are available under Section 54 if you reinvest the capital gains in another residential property.

5. How is the sale price of inherited property determined? The sale price is the amount at which the inherited property is sold in the market.