Goodbye indexation: How can the new LTCG tax rules benefit homeowners?

Is the removal of indexation benefits for homeowners a setback or an opportunity? According to experts, even as this maybe viewed as a disadvantage in the beginning, this change could actually lead to smarter investment decisions and better returns in the long run. Homeowners can potentially achieve superior, inflation-beating returns by shifting focus from tax advantages to the quality of investments.

The government has lowered the long-term capital gains (LTCG) tax to 12.5 per cent for various asset classes, including property, gold, gold and silver Exchange-Traded Funds (ETFs), fund of funds (FOF), international funds, and unlisted securities. Additionally, the holding period for these assets to be considered long-term has been reduced to 24 months, down from 36 months in some cases.

Typically, such changes would be welcomed since they broaden the investment options for long-term wealth creation with lower taxes.

"Investors can now choose assets without tax biases, focusing purely on the merit of the investment, which can enhance the quality of their portfolios. This move could reduce over-reliance on listed equities for wealth creation," said Arpit Suri, a Noida-based CA and personal finance expert.

Inflation shield gone

For homeowners, this means the government will no longer shield them from the effects of inflation. Previously, property owners could adjust their property's cost basis for inflation over the holding period. Now, it is up to the property owners to ensure their investment decisions outpace inflation to benefit from the lower tax rate.

If homeowners overpay for their property or invest in assets that do not appreciate, they will still owe a 12.5 per cent tax on the actual gains. This change rewards efficient asset buyers while removing support for those who make poor investment choices. However, homeowners can still reinvest their proceeds into another property without paying any LTCG tax.

"Homeowners can reinvest up to Rs 2 crore in capital gains from selling one property into up to two properties. Up to Rs 10 crore in gains from various assets can be reinvested into one home without incurring LTCG tax," explained Shyam Sekhar, Founder, ithought PMS

"For those reinvesting, the impact is not as severe. But, if a homeowner decides not to reinvest in another property, they lose inflation protection and must pay 12.5 per cent LTCG tax on their actual gains," Sekhar added.

Outsmart the tax shake-up

While the removal of indexation may seem unfair, history suggests it might not be detrimental in the long run. In 1999, investors could choose between a 20 per cent LTCG tax with indexation benefits or a 10 per cent tax without such benefits. Most opted for the simpler 10 per cent tax and focused on investments that delivered returns surpassing inflation.

This mindset shift, driven by an attractive tax rate, led to better investment decisions. A similar approach could be beneficial under the new LTCG regime. Homebuyers should now focus on asset allocation to improve overall asset quality.

If reinvesting gains in real estate solely for tax savings is not appealing, paying the lower LTCG tax and reinvesting in superior assets could be a better strategy. This approach could enhance asset portfolios and deliver superior, inflation-beating returns.

Smart strategies for lower burden

The lower LTCG tax facilitates capital growth and wealth creation. Investors seeking to build wealth should leverage superior asset options with lower tax rates. Gold, for example, now presents a more stable investment choice with the combined benefits of a lower LTCG tax and a two-year holding period.

As the initial reaction subsides, taxpayers will better evaluate their reinvestment options and investment strategies. This will help them make decisions on whether to reinvest LTCG in another property or pay taxes and move capital towards more promising assets.