Capital Gains Tax Reform in Budget 2024: The Future of Real Estate Investment
Introduction:
In the Financial Budget of 2024, Finance Minister Nirmala Sitharaman made an announcement indicating the scrapping of policies relating to indexation benefits for property sales, a decision that has been met with concern from real estate experts who state that it is a bad change for investors seeking to introduce capital into this sector. However, to soften the impact, the government has lowered the long-term capital gains tax to 12.5% on the sale of property, among other assets[1]. Wherein indexation adjusts an asset’s purchase price based on the prevailing inflation rate, inflating it to reflect inflation during the seller’s ownership. This effectively reduces the capital gains tax on the sale. The adjustment uses the Cost Inflation Index (CII) numbers released by the government, which account for the inflation rate in a specific financial year[2].
Implication of this change in Real Estate
Looking specifically at property sales, indexation was an important policy for real estate investors. The removal of this benefit means that investors will now have to pay taxes on the actual capital gain from each such transaction, with no adjustment for inflation. After July 23, sale of houses bought after 2001 will attract 12.5% (long-term capital gain) tax[3]. By lowering the long-term capital gains tax rate to 12.5%, the government aims to compensate for the removal of indexation benefits and maintain investor interest in the real estate sector. This reduction in tax rate applies not only to property sales but also to other financial and non-financial assets.
The removal of indexation for capital gains taxes, in my view, is significant. It means that taxes could consume all realised returns obtained via capital gains. The immediate effect of this in the real estate sector is a considerable market slowdown as people are not discouraged from trading their properties in the market. However, this may not affect how long an investor decides to hold onto a property since this applies to Long Term Capital Gains Tax, which is consistently levied as long as it is held for 10 years or longer.
Taking this into account, the real estate sector investors might see an increased trend of using Section 54 of the Income Tax Act[4] which provides an exemption on this tax if the proceeds from such a sale is reinvested in another immovable property within a fixed period of time. Sellers might also want to pass on the costs of such a transaction to the buyer, leading to a potential hike in property prices. This is concerning since it leads to a deficiency in affordable housing and ability to purchase other types of immovable property. A decreased attractiveness in the prospect of returns in this sector is also imminent, leading to a dip in the amount of capital coming into the sector.
Is it beneficial?
The Income Tax Department, via a post on their ‘X’ handle stated, “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 taxpayers.[5]” The post states that nominal real estate returns range between 12-16% per year, which might be the case in only select location in India. The national average is said to be around 10% in which case real returns are much lower. However, nominal returns are values that are not adjusted for inflation. Real returns, which consider inflation, are what investors actually receive as a function of purchasing power. It makes more sense to calculate the real returns as it helps maintain purchase power of the consumer. Removal of indexation increases the taxable amount in real estate transactions so even though the recognised returns may be higher, the tax levied would be proportionately high, an unideal shift in an economy which is trying to attract investment. Levying a tax on nominal returns incurred renders the asset as undervalued in a booming market.
[1] Government of India, “BUDGET at a GLANCE,” 2024, https://www.indiabudget.gov.in/doc/Budget_at_Glance/budget_at_a_glance.pdf.
[2] “What Is Indexation in Property Sale and How Is It Calculated? What Has Changed after Budget 2024?,” Financialexpress, July 25, 2024, https://www.financialexpress.com/money/what-is-indexation-in-property-sale-and-how-is-it-calculated-what-has-changed-after-budget-2024-3564188/
[3] The Economic Times, “Selling Property? Brace for More Tax Liability as Union Budget Takes Away Indexation Benefit – et BFSI,” ETBFSI.com, accessed July 26, 2024, https://bfsi.economictimes.indiatimes.com/news/budget/union-budget-2024/selling-property-brace-for-more-tax-liability-as-union-budget-takes-away-indexation-benefit/111968404.
[4] “THE INCOME-TAX ACT, 1961 ,” https://www.indiacode.nic.in/bitstream/123456789/2435/1/a1961-43.pdf.
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