Budget 2024 removes indexation benefit for property sales: How it impacts you

Finance Minister Nirmala Sitharaman unveiled major changes to the capital gains taxation framework in the Union Budget 2024, particularly affecting real estate transactions. The Long Term Capital Gains (LTCG) Tax on property sales has been slashed from 20 per cent to 12.5 per cent. However, this reduction comes with a notable caveat—the removal of the indexation benefits previously available for property sales.

During her budget speech, Sitharaman highlighted the rationale behind this decision. "We wanted to simplify the approach to taxation, especially for capital gains. The average taxation has come down. When we say it is 12.5 per cent, it is because we have calculated it for each of the different classes. We have brought it down to 12.5 per cent, which is the lowest in several years, encouraging investment in the market," she said.

Despite the reduced tax rate, the removal of indexation benefits has raised concerns among investors and tax experts. Indexation adjusts the purchase price of an investment to account for inflation, effectively reducing taxable profits. Without indexation, the taxable income from long-term capital gains increases, leading to higher tax liabilities for investors.

The budget document elaborates, "With the rationalisation of rate to 12.5 per cent, indexation available under the second proviso to Section 48 is proposed to be removed for calculation of any long-term capital gains, which is presently available for property, gold, and other unlisted assets. This will ease the computation of capital gains for the taxpayer and the tax administration."

Finance Secretary TV Somanathan explained that the typical real rate of return in real estate ranges from 6-16 per cent. He used an example to illustrate that if a property's value increases by 10 per cent annually, indexation would account for 4 per cent inflation, leaving 6 per cent as the actual capital gain. Somanathan emphasized that this change is intended to simplify the tax process, benefiting the middle class.

Nilesh Shah, MD of Kotak Mutual Fund, praised the simplification of real estate tax rates from 20 per cent to 12.5 per cent, acknowledging that any simplification is generally positive despite creating some winners and losers. However, he also pointed out the need to address discrepancies in capital gains tax treatment between foreign and local investors, particularly regarding derivative markets. "While the rationalization of tax rates is a welcome move, we must ensure that the same level of fairness is applied across all types of investments, including those involving foreign investors in our derivative markets," Shah said.

The impact of removing indexation benefits is not limited to real estate alone. It also affects gold and other unlisted asset classes. The indexation benefit, which applies to these assets, allows investors to adjust the purchase price for inflation, reducing the taxable gain. With this benefit removed, the taxable income from long-term capital gains on these assets is likely to increase, leading to higher tax outflows for investors.

The government has justified this move by arguing that it will lead to an overall reduction in average taxation and simplify the tax system. However, experts and investors are concerned about the potential increase in tax liabilities and the resultant impact on investment strategies. Some analysts suggest that this change might drive investors away from heavily taxed assets towards other investment avenues with more favorable tax treatments.

Finance Minister Sitharaman said that the changes are part of a broader strategy to make the tax system more straightforward and investor-friendly. "We believe that simplifying the tax structure will encourage more investments and contribute to economic growth. The new LTCG rate of 12.5 per cent is a significant reduction and should stimulate market activity," she noted.