Properties that are inherited up to four generations down the male line—father, grandfather, etc.—are called ancestral properties. However, the Income Tax Act does not treat all inherited property as ancestral property. The various provisions that are mentioned in the Income Tax Act regarding the Capital Gain Tax on Sale of ancestral Property are described in this article.
What is ancestral property?
Any property that a person inherits from any of the three listed direct paternal ancestors
- Dad
- Grandfather
- Great-grand-father
is called ancestral property.
Any property inherited from a person outside the above list is not treated as ancestral property under the Income Tax Act of 1961. Property inherited from maternal ancestors is also not considered ancestral property. Until 2005, only male members could inherit ancestral property, but the 2005 amendment states that women also have equal rights to it.
Taxation of ancestral property under the Hindu succession act
For taxation purposes, only the above ancestral properties need to be taken into account.
In the first instance, property that a natural person inherits from ancestors has no tax liability at the time of inheritance. There is currently no tax levied on it. However, once the heir sells the inherited property, the capital gains from the sale of the property will be taxable.
Tax liability on the sale of ancestral property
The tax liability of sold ancestral property depends on capital gains and its norms.
- If the property is held for more than 24 months from the date of acquisition, the gains on the property will be marked as long-term capital gains. (LTCG). This capital gain is taxed at a rate of 20.8% (including tax) with indexation.
- If the property is held for less than 24 months from the date of acquisition, the gains on the property will be classified as short-term capital gains. (STCG). This capital gain is taxed at the basic rate application to the assesse.
Calculation of capital gain on sale of ancestral property
The procedure for calculating capital gains on inherited property is given below.
Step 1: To calculate capital gains, you need to know the cost of acquisition and indexation.
Step 2: Costs of the property—The heir’s property cost nothing, but for the purposes of calculating the capital gain, the previous owner’s costs are treated as the cost of acquiring the property.
Step 3: Indexation of Costs: The year of acquisition by the previous owner is considered together with the year of sale of the property for the purpose of indexation of acquisition costs.
Step 4: The base year for such calculations was updated from 1981 to 2001.
Step 5: Calculate the cost of capital gains using the formula.
Cost of acquisition x (Cost Inflation Index Year of Sale/Cost Inflation Index Year of Acquisition)
Step 6: Subtract the cost of the capital gain from the sale price of the property to find the net profit from the transaction.
Illustration
Suppose you inherited a property in 2012 that your father bought in 2001 for Rs 8 lakh. In 2018, you decided to sell a property for Rs 30 lakh. Since the property has been held for more than three years, the transaction will be subject to LTCG.
Here is the tax calculation procedure:
- Purchase price index factor: 280/100 = 2.8.
- Here, 280 is the 2018 CII because the property was sold in 2018, and 100 is the base of the index factor.
- Purchase Cost Index Value = 2.8 x 8,00,000 (Actual Price of Property) = 22,40,000.
- So if the property is sold for Rs 30 lakh, the inflation-adjusted profit would be Rs 7,60,000 (30,00,000 – 22,40,000).
- LTCG at 20% will be applicable on capital gains only and will be Rs 1,52,000 (20% of Rs 7,60,000). You can pay this house tax online on the official government website. No tax will be paid on the purchase cost index value which is Rs 22,40,000 in this figure.
Tax benefit
The main tax advantage of inherited property is the right to be exempt from tax on profits that are obtained from the sale of the same property.
There are three options for this:
- The first option is that this can be done by reinvesting the profits into another property. This can be claimed when long-term capital gains are less than Rs. 2 crores and reinvestment is made in only two residential properties located in India.
If the profits are more than Rs. 2 million, which the heir can reinvest in one property to claim the tax exemption, These investments must be made within the specified time periods, which are one year before the sale, two years after the sale, or within three years for the property under construction. - The second option is to use the number of earnings to build a house within three years of the sale of the ancestral property.
- The third option is to invest the number of profits in capital gains bonds under Section 54EC of the Income Tax Act of 1961. The total investment limit mentioned in these bonds is limited to Rs. 50 crores per financial year.
Conclusion
As already stated, no tax is levied on inherited properties when inherited by an heir. However, as soon as he sells the property, he is obliged to pay tax on it. There are several rules under which he can apply for an exemption on a case-by-case basis.
