InvestorQ : How exactly does indexation work in practice when calculating capital gains?
Priyanka Jain made post

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

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Swati Naik answered.
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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