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When you inherit ancestral properties in India, you have multiple options. Image Credit: Shutterstock

Dubai: By default, income earned by a Non-Resident Indian (NRI) abroad is not taxable in India. But if the income in India is from gains made from investments, an NRI would have to pay taxes. But how does this rule apply to profits made from selling an ancestral property?

When you inherit ancestral properties, you have multiple options. You can keep it as your retirement plan, rent it out, gift it to your relatives or sell it for good if you want to stay abroad after retirement. However, when it comes to tax-related charges and savings, there are just as many options.

Dixit Jain

“For selling any inherited property or ancestral property, one needs to keep in mind the capital gains arising on such a sale,” said Dixit Jain, referring to the profits from the sale of the property in possession. Jain is the managing director at The Tax Experts DMCC, a Dubai-based tax advisory firm.

“The question here will be what will be the cost of the property as it was not purchased by the current seller and it was purchased a long while back. Any long-term capital gains made on selling house property are taxed at a fixed rate of 20 per cent, plus applicable ‘surcharge’ and ‘cess’.”

What are ‘surcharge’ and ‘cess’ when it comes to long-term capital gains?
Both ‘cess’ and ‘surcharge’ are important revenues collected by the Government of India. They are both an additional charge levied on the existing tax that applies to any given good or service.

While ‘cess’ is collected from every taxpayer to meet a certain purpose, the ‘surcharge’ is an additional tax collected from the taxpayers who have higher income.
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Whether you are an NRI or an Indian resident, the tax provisions for sale of inherited property are the same. Image Credit: Shutterstock

What to keep in mind when looking to sell an ancestral home?

Whether you are an NRI or an Indian resident, the tax provisions for sale of inherited property are the same. Since the property would have most likely been bought several years earlier, any profit made on sale of it will be taxed as long-term capital gains.

This is because any capital asset held by the taxpayer for a period of more than 36 months immediately preceding the date of its transfer will be treated as long-term capital asset. But what if the asset, which in this case is the property, was in possession and the transfer dated too far back?

For computing capital gains, you will have to take the fair market value (FMV) of the property as on April 1, 2001 as your cost. Let’s further understand why this date is important and also how inflation plays a highly important role when deciding on the sale price for an ancestral property.

What is fair market value (FMV) of a property during its sale?
Fair market value (FMV) in real estate is the determined price that a property will sell for. FMV is an approximate price, not an exact amount. FMV is different from the price for which a homeowner might be willing to sell a house or the price at which a buyer might be willing to purchase a house.
Due to economic factors, the value of asset or any item inflates over a period of time, even properties. Image Credit: Shutterstock

Why is it important to factor in inflation on sale of a property?

Due to economic factors, the value of asset or any item inflates over a period of time, even properties. This is why it may not be fair to tax gains which is computed without factoring this inflation and a Cost Inflation Index (CII) is fixed by the Government of India to measure inflation.

This is also used in computing long-term capital gains in relation to the sale of assets. ‘Indexation’ means to adjust the cost of an asset based on the CII. This inflated cost is considered to be the cost of acquisition while computing profit or loss on the sale of the asset, which is a property in this case.

So indexation helps reflect the actual value of the asset at present market rates taking into account the erosion of value due to inflation. CII helps in saving tax by adjusting the purchasing price of the assets sold with the current market prices. Apart from CII, having a ‘base year’ too helps. Here’s why.

Why April 1, 2001 is important when calculating long-term capital gains for an asset sale
When calculating long-term capital gains on an asset like a property ahead of its sale, there felt a need to establish a ‘base year’. Prior to 2017, the base year for fixing CII was 1981, after the Finance Act, 2017 shifted the base year from 1981 to 2001.

The reason for the shift is because it got increasingly hard for taxpayers to compute capital gains as relevant information wasn’t available for computation of FMV of assets as on April 1, 1981, which is more than 3 decades old. Currently, the base year is fixed at 2001 and CII for 2001 starts at 100.

Thus, the cost of acquisition of an asset, or property in this case, acquired before April 1, 2001 shall be allowed to be taken as FMV as on April 1, 2001, or the actual cost as chosen by the taxpayer. The cost of improvement shall include only those capital expenses which are incurred after 1 April 2001.

What’s next after the value of the ancestral property is fixed?

While shifting the base year from 1981 to 2001 helped calculate the inflated cost of the property better, for the buyer to correctly compute the taxable amount of long term capital gains, you will have to share the valuation certificate and expenses incurred for the sale transaction.

“Instead of going back to when the property was first bought and seeing how many laws had changed over that course of time, one can now take the value of the first buyer and the same can be indexed using inflation factors to arrive at the right capital gains,” added Jain.

“If the property was purchased before April 1, 2001, then to arrive at cost one needs to get the valuation of the property as of April 1, 2001 from a government registered-valuer and then that value will become the cost to the current seller.”

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The process of evaluating the value of an ancestral property has helped reduce capital gains and related tax burden. Image Credit: Shutterstock

How else can you save on tax when selling an ancestral property?

While the process of evaluating the value of an ancestral property has helped reduce capital gains and related tax burden, in case you wish the buyer not to deduct tax (TDS), you can also approach the jurisdictional income tax officer to issue you a certificate for non-deduction of TDS.

The major tax benefit on inherited property is one can claim tax exemption on the gains that are made from the sale of the same property. It can be done by reinvesting the gains in another property.

This can be claimed when the long term capital gains are less than Rs20 million (Dh900,307) and the reinvestment is done only in a maximum of two residential properties located in India. If gains are more than Rs20 million the inheritor can reinvest in one property to claim the exemption of tax.

You can either use the gains to construct a house within three years from the sale of the ancestral property, or you can invest the profits in capital gains bonds within six months from sale of the property, with the total investment limit in bonds restricted to Rs5 million (Dh225,076) annually.