No Indexation Benefit if property sold at a loss

The Government took away the indexation benefit for properties in Budget 2024.

After receiving feedback, the Government relented and gave back the indexation benefit to properties bought before July 23, 2024.

Now, you would assume that, for the properties bought before July 23, 2024, there is no change in capital gains taxation. Everything is back to normal.

That’s the understanding most of us have, isn’t it?

However, that’s not entirely correct if your property investment has made only mild gains or even suffered losses.

When a property investment does NOT perform well, you get relief in 2 ways.

1. You may not have to pay much (or any) capital gains tax on the sale of such an investment. No capital gain, no capital gains tax.
2. More importantly, if you book a capital loss, you can utilize this loss to set off capital gains from sale of other capital assets in the same year or in the coming year. This can reduce your tax liability in the same year or in the coming years. And indexation plays a big role in reducing taxable capital gains OR increasing capital losses.

While the Government has doled out the carrot of relenting on the indexation benefit for the properties bought before July 23, 2024, it has smartly taken away the benefit as specified in (2).

Hence, if your property investment was bought before July 23, 2024 or has underperformed, you would get indexation benefit ONLY to REDUCE your Capital GAINS, but NOT to INCREASE your Capital LOSSES.  Quite a bit hit in my opinion.

Moreover, if you are an NRI, you haven’t even been offered this relief. This relief is offered only to Resident Individuals.

Let’s discuss all this and more with examples in this post.

The Backdrop

Before Budget 2024 announcements, any long-term capital gains (holding period > 2 years) on sale of property were taxed at 20% (after indexation).

Before Budget 2024 (20% With Indexation)

Long Term Capital Gain/Loss = Sale price – Indexed cost of purchase/improvement

Tax at 20% on such calculated LTCG.

Budget 2024 took the benefit of indexation away from real estate transactions.

After Budget 2024 (12.5% Without Indexation)

Long Term Capital Gains/Loss = Sale price – Cost of purchase/improvement

Tax at 12.5% on such calculated LTCG.

The Relaxation for Property Transactions but with Caveats

After receiving feedback from various stakeholders, the Government reinstated the indexation benefit for properties bought before July 23, 2024, but with caveats.

Let’s consider an example.

You sell a property bought before July 23, 2024, after holding it for 2 years.

Since the holding period is greater than 2 years, the resulting gains will be considered long-term capital gains.

Calculate the following two amounts.

1. LTCG1 = Sale price – Cost Price. TaxLiability1 = 12.5% * LTCG1
2. LTCG2 = Sale price – Indexed Cost of Purchase. TaxLiability2 = 20% * LTCG2

Your tax liability will be the lower of the two calculated tax liabilities.

Your final tax liability = Lower (TaxLiability1, TaxLiability2)

This seems to suggest that the Government has kept things unchanged for the properties bought before July 23, 2024.

Unfortunately, things are not the same. We will also understand this with the help of illustrations later in the post.

Before we delve upon the problem with relaxation (or rather how this is worded), let’s first see how the Government has effected these changes (Budget 2024 and the subsequent relaxation).

Which Sections of Income Tax specify Capital Gains Taxation?

Section 2(42A): specifies the holding period for long term capital gains.

Section 48: specifies how to calculate long-term capital gains.

Short-term capital gains are added to your income and taxed at respective slab rate. Section 111A makes an exception for stocks and equity mutual funds.

Section 112: specifies the tax rates for long term capital gains. Section 112A makes an exception for stocks and equity funds.

In the Budget 2024, the indexation benefit was withdrawn through amendment to Section 48. The tax rates on LTCG were changed through amendment to Section 112. While relaxing the indexation benefit, the Government has not made any changes to Section 48, but only Section 112.

How has the Government brought this change (relaxation)?

The Government has brought this relaxation by amending Section 112 (and not Section 48).

Essentially, the Government has NOT changed the methodology of calculating the capital gain/loss for properties bought before July 23, 2024. The capital gains calculation remains the same (as modified through Budget 2024).

Long Term Capital Gain = Sale Price – Cost of Property (Specified in Section 48). Notice there is still no indexation benefit.

The Government has only changed the way the tax is calculated. Under Section 112.

At the time of calculation of tax liability, it says calculate tax liability under both methods. 12.5% without indexation. And 20% with indexation. And pay the lower tax liability. (Specified in Section 112).

Copying an excerpt from the Finance Act (2), 2024

This presents a unique challenge.

You can be indifferent if your real estate investment has paid off well. However, you have a problem if your real estate investment has made only mild gains or losses.

What if there is no gain? What if there is a loss?

Even in the case of capital loss, there are 2 possibilities.

1. You bought for Rs 30 lacs and sold for Rs 28 lacs. That is a clear nominal loss.
2. You bought for Rs 30 lacs and sold for Rs 35 lacs. No nominal loss. But the indexed cost of purchase is Rs 45 lacs.

The relaxation provided to real estate investors through amendment to Finance Bill, 2024 will ensure that you do not pay higher taxes (than you would have if indexation were allowed).

However, this does not provide you with relief on capital losses (carry forward loss). With indexation benefit, you would have booked a much higher capital loss. A higher capital loss/carry forward loss can be used to reduce capital gains tax liability in the same year or in the coming years.

In short, you do not pay more tax, but there is a possibility that you book a lower capital loss (or carry forward lower loss) after Budget 2024 changes despite the relaxation.

Let’s understand this with the help of a few illustrations.

Illustrations: For Capital gains tax calculation

We consider 4 scenarios.

1. Good Profit (Cost: Rs 30 lacs, Sale Price: Rs 60 lacs)
2. Mild Profit (Cost: Rs 30 lacs, Sale Price: Rs 35 lacs)
3. Mild Loss (Cost: Rs 30 lacs, Sale Price: Rs 28 lacs)
4. Heavy Loss (Cost: Rs 30 lacs, Sale Price: Rs 20 lacs)

Focus on the final tax paid and the capital loss/carry forward loss.

No problems in the above example.

Capital Gains Tax Liability is the same (as expected).

But, under the old method, you would have booked loss of Rs 10.37 lacs. You could have used this loss to set off capital gains from sale of, say, stocks and avoided paying capital gains tax of 10.37 lacs * 12.5% = ~1.30 lacs.

But with the removal of indexation benefit (New Method), you do not get to book this capital loss. That’s a negative for you.

CG Tax is same, but notice the difference between the capital loss booked.

Tax liability is the same, but the capital loss is much higher under the old method (with indexation).

As you can see, the final tax to be paid (or not to be paid) is the same under both old and new method. But the capital loss/carry forward loss is different.

This happened because the Government did not change the calculation of capital gains under Section 48. It only offered relaxation on the taxes by allowing investors to pay a lower tax under Section 112.

Since the capital gains/loss calculation does not include indexation anymore, the capital loss (if any) goes down drastically.

Non-residents (NRIs) have been short-changed

We saw earlier in the post the indexation benefit is available on sale of properties bought before July 23, 2024, but there were caveats.

If you are an NRI, there is more bad news.

1. The indexation benefit shall NOT be available to Non-residents (NRIs), even for properties bought before July 23, 2024.
2. The choice of paying taxes at 12.5% (without indexation) or 20% (with indexation) for properties bought before July 23, 2024 is available only to resident individuals and HUFs.
3. So, if you are an NRI and have sold a property on or after July 23, 2024, you do NOT get indexation benefit. Being an NRI, you pay tax on LTCG at 12.5%.

All the illustrations shown earlier in the post are only for resident individuals.

For NRIs, there is no choice between 12.5% without indexation or 20% after indexation.

Disclaimer: I am not a tax expert and there may be gaps in my understanding. Please consult a chartered accountant before acting on the contents of this post.

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This post is for education purpose alone and is NOT investment advice. This is not a recommendation to invest or NOT invest in any product. The securities, instruments, or indices quoted are for illustration only and are not recommendatory. My views may be biased, and I may choose not to focus on aspects that you consider important. Your financial goals may be different. You may have a different risk profile. You may be in a different life stage than I am in. Hence, you must NOT base your investment decisions based on my writings. There is no one-size-fits-all solution in investments. What may be a good investment for certain investors may NOT be good for others. And vice versa. Therefore, read and understand the product terms and conditions and consider your risk profile, requirements, and suitability before investing in any investment product or following an investment approach.