Well, what is indexation?
In other words, indexation represents the rise in acquisition cost of an asset on account of inflation. This adjustment is allowed to decrease the effect of inflation on your investment by putting the cost of the property in tune with the prevailing economic conditions. It is relevant in cases where a real estate investor calculates his capital gains tax from the sale of a property which he has held for a long period.
The gain from the sale of an Indian immovable property held for more than 24 months would be chargeable as long-term capital gain, which in general is charged at 20%. But this indexation benefit helps to reduce some of that gain for tax computation purposes by upgrading the cost of purchase in factor with inflation. This Cost Inflation Index (CII) is published every year by the government for use in the computation of adjustments.
How does Indexation work?
Indexation allows an investor in real estate to inflate the acquisition cost of his property with the rise in the cost of living over a certain period. The method includes original purchase price times a ratio calculated from CII. Thus, the resultant calculated figure on purchase price shall be deducted from selling price to determine taxable capital gain.
Benefits of Indexation to Real Estate Investors
- Lesser Liability to Tax: The most important privilege of indexation is standing in and helping one reduce the quantum of capital gains liable for the payment of tax. In fact, after indexing the purchase price for inflation, there is a substantial reduction in taxable gains.
- Encourages Long-Term Investment: The benefits under indexation are allowed only in the case of long-term capital gains-that an investor has to hold property for more than 24 months-it encourages the investors to retain the real estate assets for longer tenures, hence providing stability in the market.
- Inflation Adjustment: The very notion of indexation is to account for the erosion of purchasing power due to inflation-so that one is not taxed on unrealized gains due to an increase in the value of property, principally post-inflation.
- Higher Investment Returns: By reducing the taxable gains, indexation ensures the investors retain more profit hence yielding better returns overall.
Cost Inflation Index (CII) in Simple Words
The cost of acquisition so indexed shall be determined by the Cost Inflation Index. Government of India issues CII to be applied for working out inflation-adjusted cost at the end of every financial year.
This gives a huge impact to the tax output of the real estates especially for those properties which are held up for many years. As can be told from the higher CII values of the later years the increment due to the inflation benefits the seller and further adjusts the original purchase price hence reducing the taxable gains.
Examples of a few recent CII values:
- 2018-2019: 280
- 2019-2020: 289
- 2020-2021: 301
- 2021-2022: 317
- 2022-2023: 331
- 2023-2024: 348
It is these values that enable investors to plan sales of properties in such a way as to maximize benefits arising out of indexation.
Impact of Indexation on Investment Decisions
The effect of indexation on tax savings perhaps would have an impact on some of the decisions that come under real estate investment. These are as follows:
- Sale Timing: It is the investment period for which an investor holds onto a property. He can also hold it even longer in order to profit from lower capital gains through indexation. Again, the CII will show a trend and help to benefit from better timing during the sale of the property.
- Investment Strategy: The beauty of indexation, in this case, would be the fact that the investor can balance his portfolio between real estate and other asset investments-assured that more funds can be channeled into long-term real estate investment as opposed to short-term assets.
- Tax Planning: It would also afford the investor better avenues of planning his estate transactions from a tax liability point of view in cases of high-value sales of properties. It finds its application in all estate planning and generational transfer of property where minimum tax implications are concerns of prime importance.
Conclusion
Indeed, indexation acts as a strong tool in real estate investments to hedge returns from the evils of inflation, besides reducing one’s liabilities of taxation. In fact, proper understanding of application of Cost Inflation Index and accruals on long-term investment will go a long way in helping improvement of financial returns on investment in real estate. Knowing this-that you’re on the inside track as far as indexation and tax laws go in their constant evolution and flux of interpretation-places you even better out there in property investments, making calculated decisions.
