Can indexation benefit removal stabilise property prices?

Can indexation benefit removal stabilise property prices?

Notwithstanding the removal of indexation benefit for the purpose of computing long term capital gains (LTCG) on property, the demand for property bought for self-consumption may not get hit. In fact, this could control speculative buying in the real estate sector and stabilise the prices, aiding the first-time property buyers

There is an overwhelming view that tax implications for investors or purchasers of real estate assets would significantly go up now given the indexation benefits on properties purchased before 2001 have been taken away by the government. However, it could turn out to be boon for first time buyers who plan to buy assets for own use

Through indexation, the purchaser of a property was allowed to adjust inflation over time over the cost price of that asset. This adjustment helped him / her to reduce tax payout at the time of selling a property in the form of long-term capital gains (LTCG).

Finance Minister Nirmala Sitharaman in this year’s budget reduced LTCG on the sale of property from 20 per cent to 12.5 per cent while doing away with the indexation benefit. The announcement became effective from the budget day itself which was July 23, 2024.

While the government’s argument is rationalisation of tax by reducing the LTCG, it sees removal of indexation akin to tax simplification. The government has also clarified that properties purchased before 2001 will continue to enjoy indexation benefits. Moreover, the rule would not apply to properties inherited by individuals.

As the dust around the move is settling down, it is becoming clearer that the actual tax outgo for the property seller would increase in most cases.

The government publishes a cost inflation index (CII) on the annual basis which was being used to determine the cost of acquisition of the property. The price is then adjusted for inflation so the difference between the selling price and the cost price is narrowed which thereby reduces the tax liability on the seller.

What will happen now is that the original price will be considered to compute the gains and hence the LTCG.

Since the impact of this decision is still to play out on the investors’ appetite for real estate assets purely from the investment standpoint, I believe demand for property bought for self-consumption may not get hit. In fact, this could control speculative buying in the real estate sector and stabilise the prices, aiding the first-time home buyers.

Real estate sector has seen a strong revival since the onslaught of Covid-19, after which offices were shut and work from home became a new reality. People upgraded their homes with separate office spaces, bought bigger and more comfortable houses. As a result, we have seen property prices across the length and breadth of the country go up, significantly.

The trend is expected to continue even now as the demand remains strong especially in tier-1 cities.

In this budget, the government has also taken several measures to promote the affordable housing segment including increasing allocation for government’s flagship scheme Pradhan Mantri Awas Yojana (PMAY). So, we do not expect a material negative shift in demand from the buyers’ side.

As for the investment purpose, if the realty market remains buoyant, it could continue to see inflows and the investors may not mind paying a premium on higher profits.

The industry eventually adjusts to the changes but a predictable policy remains a strong trigger towards its growth. While the move to lower LTCG is a welcome step, the removal of indexation did come as a surprise. The industry hopes no more adverse policy measures.

A media report has highlighted industry’s concerns on a couple of other aspects. One such aspect is whether the government is considering to discontinue inclusion of home loan interest and the stamp duty while determining the cost of acquisition of property for computation of capital gains.

Currently, stamp duty, registration and home loan interest payment above the annual limit of Rs 2 lakh deduction is considered while arriving at the cost of acquisition of a property and thus calculating capital gains at least judicial orders have held that interest on loans obtained for acquiring property could be considered as part of the cost of acquisition.

This Economic Times report also points out why the industry is fearing what it fears — the policy shocks. Quoting an expert, it said that the Finance Act, 2023, has introduced a significant amendment to Section 48 of the Income-tax Act, 1961, effective from April 1, 2024. This amendment marks a departure from the previous interpretation of law established by various tribunals and high courts regarding the treatment of interest on capital borrowed for property acquisition.

The amendment has been made in clause (ii) of Section 48 where a proviso says, “Provided that the cost of acquisition of the asset or the cost of improvement thereto shall not include the deductions claimed on the amount of interest under clause (b) of Section 24 or the provisions of Chapter VIA.”

So, if one has a loan interest above Rs 2 lakh, the amount above it may not be included in the cost of acquisition which effectively means more tax payment.

Section 24(b) of the Income Tax Act, 1961 allows exemption of up to Rs 2 lakh towards income tax.

While it is still early to assume anything unless it comes out from the horse’s mouth, it will not be a great move from the investors standpoint.

The government will likely be mindful of the impact and is expected to take a decision that is best for the industry, buyers and the real estate investors.

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