InvestorQ : How exactly does indexation work in practice when calculating capital gains?

# How exactly does indexation work in practice when calculating capital gains?

2 years ago
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The Income Tax Department announces the Capital Gains index for each year and this index are used to adjust your cost of acquisition. But how is the adjustment made? The idea is to provide for some amount of inflation and reduction in the overall capital gain. For example, if inflation is 10%, then Rs.100 will have a real value just Rs.81 at the end of 2 years. That is the entire idea of indexation. Let us take some sample index numbers to understand how the actual calculation is done for indexed capital gains. Here is how indexation is applied while calculating capital gains on property or any other asset where indexation is allowed.

 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 551 582 632 711 785 852 939 1024 1081 1125

To get a clearer picture let us consider a practical illustration. Assume that an investor had purchased a property in Chennai in January 2008 for Rs.50 lakhs and sold it in January 2017 at Rs. 1.45 crore. What will be his capital gains tax payable? Remember, you can choose to either pay 10% on the absolute capital gain or 20% on the indexed capital gain. Here is how it will work in the two scenarios…

 Details of Capital Gains A – Pay 10% on capital gains B – Pay 20% on indexed gains Cost of acquisition of the property Rs.50,00,000 Rs.50,00,000 Indexed Cost of Acquisition (*) N.A. Rs.1,02,08,711 Sale Price of property Rs.1,45,00,000 Rs.1,45,00,000 Indexed Capital Gains Rs.95,00,000 Rs.42,91,289 Capital Gains Tax payable Rs.9,50,000/- Rs. 8,58,258

In the above case since the asset was purchased in FY 2007-08 and sold in FY 2016-17. Now look for the relevant index numbers from the table, which are 1125 and 551. Therefore, this is you go about calculating the indexed value (*) = (50,00,000 x (1125/551)

From the above illustration it is quite obvious that the property investor gets a real and tangible benefit by opting for indexation of capital gains. You must plan your property sale transaction in such a way that you get the benefit of dual indexation. For example if you buy a property on March 25th 2014 and have sold the property on April 05th 2017, then you have virtually held the property for 3 years and 10 days only but you get the indexation benefit for four years, since the financial years shift. This can make a meaningful difference to your final tax incidence. Use these indexation year shifts smartly.

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