Impact of Removal of Indexation and LTCG 12.5% on Realty Investors [2024]

The removal of indexation benefits and introduction of a 12.5% LTCG tax rate for real estate has generated varied reactions among investors. This post examines how these changes affect tax liabilities, using practical examples to highlight the potential advantages and disadvantages for realty investors.The recent Union Budget brought two changes on how income from real estate property will be taxed. First, it removed the indexation benefit on long-term capital gains (LTCG). Second, it reduced the LTCG tax rate from 20% to 12.5%. The decisions has left realty investors with mixed feelings. Many people are not happy that the indexation benefit has been removed.Post the budget announcement, on 24-July-2024 at about 10AM, Income tax department posted multiple tweets in support of this decision. In the tweet, they posted a calculation showing how removal of indexation and lowering of LTCG Tax to 12.5% is “beneficial for the majority tax payers.“These tweets confused me even more. Hence, I thought it is necessary to declutter the tweet as well (read here)So in this blog, I will do two things. First, we’ll explore the practical implications of this change by calculating and comparing the tax liabilities under the old and new regimes. Second, I’ll also declutter the tweet of the Income Tax department and show you why it may not be factually correct.1. Income Tax Liability Calculation As per New Tax Rules (No Indexation and 12.5% LTCG)Suppose Mr.Sunil bought a flat in year 2010 for Rs.4000000 (40 Lakhs). He sold this flat in the year 2024 for Rs.1,00,00,000 (1 Crore). Let’s calculate the income Tax Liability of Mr.Sunil on the sale proceeds of his flat.To calculate the income tax liability on the sale proceeds of Mr.Sunil’s flat under the new rule, following are the steps:Step#1: Determine the Cost of Acquisition. The cost of acquisition considered will be simply the purchase price since indexation is not applied. In case of indexation, a inflated cost of acquisition is considered which thereby reduces the capital gain. This point will become clearer in the step-by-step calculations shown in next example.Step#2: Calculate the Capital Gains: Use this formula to calculate the capital gain tax which will be = Sale Price – Cost of Acquisition.Step#3: Calculate the LTCG: As the property in consideration has been held for 14 years (2010 to 2024), more than the LTCG limit of 24 months, the LTCG tax rates will be applicable. LTCG Tax liability will be = Capital Gains * LTCG Tax Rate.The CalculationCost of Acquisition: Rs.40,00,000Capital Gains: Rs.60,00,000 (=100,00,000 – 40,00,000)Calculate the LTCG Tax Liability: Rs.7,50,000. (=Rs.60,00,000 * 12.5%).Under the new rule, Mr.Sunil’s income tax liability on the sale proceeds of the flat would be Rs.7,50,000.[Please Note: Between 2010 and 2024 (14 Years), the property price grew at a rate of 6.77% per annum from Rs.40 Lakhs to Rs.100 Lakhs. This is an actual example of Non-Metro Tier-1 city of India.]2. Income Tax Liability Calculation As per Old Tax Rules (With Indexation and 20% LTCG)We’ll take the same example of Mr.Sunil. He bought a flat in year 2010 for Rs.40,00,000 (40 Lakhs) and sold it in the year 2024 for Rs.1,00,00,000 (1 Crore). Let’s compute his income tax liability as per the old tax regime (before the July 2024 Union Budget announcement).To calculate the income tax liability on the sale proceeds of Mr.Sunil’s flat under the old rule, following are the steps:Step#1: Determine The Cost of Inflation Index (CII): This must be done for the year of purchase (2010) and the year of sale (2024). You can get a table with CII’s of all financial years here.Step#2: Calculate the Indexed Cost of Acquisition: The indexed cost can be calculated by using this formula = (CII of 2024 / CII of 2010) *Cost of Acquisition.Step#3: Calculate the Capital Gains: Use this formula to calculate the capital gain tax which will be = Sale Price – Cost of Acquisition.Step#4: Calculate the LTCG: The property in consideration has been held for 14 years (2010 to 2024). It is more than the LTCG limit of 24 months. Hence, the LTCG tax rates will be applicable. LTCG Tax liability will be = Capital Gains * LTCG Tax Rate.The CalculationCost of Acquisition: Rs.40,00,000CII for 2010 and 2024: For the year of purchase (2010), the CII is 167. For the year of sale (2024), the CII is 363.Indexed Cost of Acquisition: Rs.86,94,610 (=363/167 * 40,00,000)Capital Gains: Rs.13,05,389 (=100,00,000 – 86,94,610)LTCG Tax Liability: Rs.2,61,078 (=Rs.13,64,670 * 20%)Under the old tax rule, Mr.Sunil’s income tax liability on the sale proceeds of the flat would be Rs.2,61,078.[Please Note: Between 2010 and 2024 (14 Years), the property price grew at a rate of 6.77% per annum from Rs.40 Lakhs to Rs.100 Lakhs. This is an example of Non-Metro Tier-1 city of India]3. Comparison Between Old and New Tax RegimeFrom the above comparison, it is clear that under the new tax regime (without indexation) Mr.Sunil’s income tax liability is more than twice the old tax regime (with indexation).It is obvious that the removal of indexation benefits is detrimental to Mr. Sunil.It the difference is so obvious, how the tweets of Income Tax Department is saying that the new tax rule is “beneficial for the majority tax payers“? Before we can check if this statement is factually correct or not, we’ll have to first decode the tweet (jump to point number 5)4. Another Example of a Tier-II City in IndiaSuppose a person bought a residential apartment in a tier-II Indian city in year 2004. The purchase cost was Rs.17,00,000 (Rs.17 Lakhs). He sold this property in year 2024 at Rs.98,00,000 (Rs.98 Lakhs). Let’s calculate his income tax liability as per the old and new tax regime.Cost Inflation Index (CII) Calculation:CII for the financial year 2004-05: 113CII for the financial year 2024-25: 363DescriptionOld Regime (With Indexation)New Regime (Without Indexation)Purchase Cost (Rs.)17,00,00017,00,000Sale Price (Rs.)98,00,00098,00,000Indexed Cost of Acquisition (Rs.)54,61,080N/ACapital Gain (Rs.)43,38,92081,00,000Tax Rate (%)20%12.5%Tax Liability (Rs.)8,77,78410,12,500Under the old tax regime with the indexation benefit, the tax liability would be Rs. 8,77,784. In contrast, under the new tax regime without the indexation benefit but with a lower tax rate of 12.5%, the tax liability increases to Rs. 10,12,500.Even in this example, where the property price grows faster a Tier-II city, there is a higher tax burden for the seller under the new regime.[Please Note: Between 2004 and 2024 (20 Years), the property price grew at a rate of 9.15% per annum from Rs.17 Lakhs to Rs.98 Lakhs. This is an example of Tier-II city of India]5. Decoding The Tweet of Income Tax DepartmentPost the budget announcement, on 24-July-2024 at about 10AM, Income tax department posted multiple tweets in support of this decision. In their tweet they wrote this:“Nominal real estate returns are generally in the region of 12-16 per cent per annum, much higher than inflation. The indexation for inflation is in the region of 4-5 per cent, depending on the period of holding. Therefore, substantial tax savings are expected to a vast majority of such tax payers. Some cases are given below in this regard to illustrate the tax in both scenarios.“In their tweet, they also uploaded a few calculations supporting their tweet. I’ll show you their calculation for a real estate property having a 15-year investment horizon.Let’s understand the perspective of the Income Tax DepartmentNominal Returns vs. Inflation: They say that for a real estate property nominal returns are typically in the range of 12-16% per annum.Inflation: The indexation for inflation adjusts the purchase price based on an average inflation rate of 4-5%.Let’s break down the table provided by the Income Tax Department. The table compares the tax implications under the old rule (with indexation) and the new rule (without indexation) for a property purchased in 2009-10 and sold in 2024-25.Cost of Acquisition (CoA): This is the original purchase price of the property. For simplicity, they have used Rs.100 as the base price.Cost Inflation Index (CII): The CII for the financial year 2024-25 is 363. The CII for the financial year 2009-10 is 148.Indexation Factor: This factor adjusts the original cost for inflation. Indexation factor in this case will be 2.45 (=363/148)Indexed Cost of Acquisition: The formula for the adjusted purchase price considering inflation will be COA * Indexation Factor. The indexed cost will be 245 (=100 * 2.45)Table Explanation:Sale ValueReturn per annum (pa)Capital Gain (Old)Tax (Old)Capital Gain (New)Tax (New)70013.90%455916007560012.70%3557150062.550011.30%255514005049011.20%2454939048.8Example Calculation:For a Sale Value of Rs. 700 (Old Regime):Capital Gain (After Indexation): 455 (= 700 – 245)Income Tax Liability: 91 (= 455 * 20%)For a Sale Value of Rs. 700 (New Regime):Capital Gain (Without Indexation): 600 (= 700 – 100)Income Tax Liability: 75 (= 600 * 12.5%)In this example, the tax liability under the new regime (Rs. 75). It is lower than under the old regime (Rs. 91), despite the removal of indexation benefits.This illustrates the point made by the Income Tax Department that, for properties appreciating at higher rates (around 11-16% per annum), the new tax regime could result in substantial tax savings. But what happens to properties that is appreciating at a rate lower than 10% per annum?Though this calculation is not wrong, but I think it is not representing the real picture. How? This is what I will explain in the next section.6. Price Appreciation of Properties in IndiaBased on the data I could collate about the real price appreciation of properties in India, here’s the summary. The average Compound Annual Growth Rate (CAGR) for the price appreciation of a 2BHK (1000 SQFT) flat in the listed cities over the past 10-15 years are as below:Mumbai: The real estate market in Mumbai has seen an average annual appreciation rate of approximately 8% over the past decade.New Delhi NCR: The CAGR for property prices in the NCR region is estimated to be around 7% over the last 10-15 years.Kolkata: Property prices in Kolkata have appreciated at a CAGR of around 7.5% during this period.Chennai: The average annual appreciation rate in Chennai has been about 8%.Bangalore: Bangalore’s real estate market has seen a robust growth rate with a CAGR of about 10%.Pune: Pune’s property prices have appreciated at a CAGR of approximately 7%.Hyderabad: Hyderabad has witnessed a significant appreciation with a CAGR of around 11% due to recent rapid development.Ahmedabad: The CAGR for property prices in Ahmedabad has been around 6.5%.Typical Tier-II Cities: The CAGR for property prices in these cities can range between 9-10% per annum.These rates shows that real estate investments in these cities have generally outpaced inflation. But they are much below the assumed growth rate of @IncomeTaxIndia of 11.2% to 13.9%. Typically, even in best of cases, prices of residential real estate properties rise at around 10% per annum.What does it mean? For majority public, removal of indexation will result in higher income tax outgo.ConclusionThe removal of indexation benefits and the lowering of LTCG (from 20% to 12.5%) on real estate have significant implications for investors. While the intention behind these changes might be to simplify the tax regime and potentially benefit those with high property appreciation rates, the practical impact can vary.The above examples illustrate that, most residential properties in India (Tier-I and Tier-II cities) have a much lower price appreciation rates (less than 10% per annum). Sale proceeds of these properties will attract a higher income tax liability.The government’s claims of widespread benefit might hold for certain scenarios, but I think, the reality for most real estate investors is a less favorable outcome.Suggested Reading: