Tax Saving: Capital Gains arising from Inherited Property

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Tax Saving: Capital Gains arising from Inherited Property

Tax Saving: Capital Gains arising from Inherited Property 

Property can be either self purchased property or can be property acquired by way of Inheritance. Various questions arises if the inherited property is sold by the taxpayer. Question arises more particularly with regard to the

  1. Relevant date for calculating the capital gain.
  2. Cost of inherited property so sold. Cost if the property is acquired long back by the forefathers and no documents as to cost of its exits
  3. Admissibility of indexation benefit on such assets, more particulary if the assets is sold within 2 years of its inheritance
  4. Deduction towards cost of improvement, more particularly if the original owner as well subsequent owner, both have incurred towards the improvement of the property?

Let us try to understand it one by one.

Period of Holding:

It may be noted that Explanation 1(i)(b) to Section 2(42A) is relevant for determining the period of holding of capital assets. It provides that the period of holding will be from the date the “previous owner” had acquired the capital asset.

 Explanation 1].—(iIn determining the period for which any capital asset is held by the assessee—

(a) ……………..

(b) in the case of a capital asset which becomes the property of the assessee in the circumstances mentioned in sub-section (1) of section 49, there shall be included the period for which the asset was held by the previous owner referred to in the said section ;

In short, 2(42A) referrers to section 49(1) for recknoning the holding period of earlier owner.
Section 49(1)(a) covers various circumstances and includes  transfer by Gift or Will or Inheritance.
Reading above two sections in conjunction, in case of inherited property the date for the purpose of determining period of holding is to be reckoned from the date it was originally acquired by the original owner

Cost of Acquisition:

The person inheriting the property by way of inheritance doesn’t have to incur any expense. The actual cost in the case of person inheriting the property is actually Nil. However, section 49 of the Income Tax Act provides that the cost for acquiring the asset in hand of the person inheriting the property will be the cost of the original owner. In short, the cost will remain the same as was there in the hands of the original owner.

To further simplify, the cost of original owner and the date of acquisition thereof by the original owner is considered as same in the hands of the person inheriting it.

Confusion arises if the property is a old property where no documents or records as to its cost is available. In all such scenario where the property is acquired by the original owner prior to 01.04.2001 then the assessee need not refer to the actual cost by the original owner. Assessee can adopt the fair market value of the property as on 01.04.2001 for computing capital gain.

Indexation Benefit:

Here comes an interesting outcome. Section 48 which offers indexation benefit applies to any resident who have sold any long term capital assets. The wording of the section is done in such a way that the indexation benefit is given to the seller “from the date the assets is first held by the Assessee”. Technically speaking, indexation benefit is available from the date of inheritance and not from the date the property was acquired by the original owner.

However, judiciary has not accepted the literal interpretation of the statue as the indexation benefit is available to the assets and not to the assessee. Judiciary has given the indexation benefit from the date the assets was acquired by the original owner and not form the date of inheritance. It was first held by ITAT Mumbai Special Bench in its decision in case of CIT vs Manjula J Shah wherein it was conveyed that the date the original owner will be the date the from when the indexation need to considered in the hands of inheritor.

This Special Bench decision was later on further confirmed by the Mumbai High Court in CIT-12 vs Manjula J Shah [2013] 355 ITR 474 (Bombay)  with following observation:

In the result, that the Tribunal was justified in holding that while computing the capital gains arising on transfer of a capital asset acquired by the assessee under a gift, the indexed cost of acquisition has to be computed with reference to the year in which the previous owner first held the asset and not the year in which the assessee became the owner of the asset.

To conclude, indexation of cost is allowed from the date the previous owner had acquired the asset.

 Improvement cost:

There is a specific provision in in the Act in Section 55(1)(b)(2)(ii) of the I.T. Act which provides that where the capital asset became the property of theassessee by any of the modes specified under Section 49(1) of the Act, not only the cost of improvement incurred by the assessee but also the cost of improvement incurred by the previous owner shall be deducted from the total consideration while calculating capital gains.

In short, improvement cost originally incurred as well as those incurred subsequently after inheritance is eligible for deduction while computing capital gain.

To conclude, the computation of capital gain in case of inherited property is as simple as in any other case.

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