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Long Term Capital Gains (LTCG) on Sale of a House – Calculation and Income Tax

Sale of a house often results in long term capital gains. But its calculation is not very simple – the cost of acquisition has to be indexed using the cost inflation index numbers. The cost of improvement also has to be added before calculating the capital gain.

This article guides you through the entire process by giving step by step calculations for arriving at the long term capital gains on sale of a house. You can also download a spreadsheet containing examples for many different scenarios.

In “Long Term and Short Term Capital Gain – Income Tax Calculation”, we understood what a capital asset is, what capital gain is and how it is classified into long term capital gain & short term capital gain.

We also briefly touched upon the topic of income tax calculation on these gains.

Now, let’s understand calculation of long term capital gain on a sale of a house (a flat or an apartment or an independent house – any residential property) in detail.

(Do you know when the capital gain from the sale of a house is classified as long term capital gain? Please read “Long Term and Short Term Capital Gain – Income Tax Calculation” to find out)

 

How Inflation Affects Cost of Acquisition

Let’s say you bought a house in Jan 1989 for Rs. 2 Lakhs. You sell it in Oct 2007 for Rs. 20 Lakhs.

Login Required Download a spreadsheet illustrating the example used in this article, and long term capital gain calculation for many different scenarios.  (You need to be logged-in to download the spreadsheet. For free registration that takes less than a minute, please click here. To know the benefits of registration, please click here)

What is your profit?

Sounds like an odd question, right? This is something that even a 5th standard student can answer! Obviously,

Profit = Sale Price – Cost Price (or Acquisition Price)

And therefore, your profit in this case would be Rs. 20 Lakhs – Rs. 2 Lakhs = Rs. 18 Lakhs.

Well, it is in fact right. But do you think the value of Rs. 2 Lakhs in 1989 was the same as it was in 2007?

Of course not! Rs. 2 Lakhs could buy a lot more in 1989 than in 2007. The value of the Rupee decreases every year due to inflation.

So, is it right if we just subtract a price paid in 1989 from the price we obtained in 2007 to calculate the profit?

Logically thinking, this wouldn’t give us the true profit.

Fortunately, the department of income tax also thinks this way! And therefore, in the income tax rules, there is a provision of indexing the cost price in order to arrive at a price that is comparable to the sale price. (This price is called the Indexed Cost of Acquisition)

 

Indexation Using the Cost Inflation Index

An important concept to understand here is that of the cost inflation index.

This is a number derived for each financial year by the Reserve Bank of India (RBI), and it depends on the prevailing prices during that financial year.

The number in itself doesn’t convey much. But the change in the cost inflation index figure is indicative of the inflation during those years.

Thus, if we see the change in the cost inflation index between say 1989 and 2007, it would give us an indication of the change in prices between these years.

Or, in other words, it would give us an indication of the change in the value of the Rupee between these years.

And therefore, as you would have guessed by now, we need to use the cost inflation index for these two years to find the Indexed Cost of Acquisition.

 

Cost Inflation Index Table

Financial Year Cost Inflation Index (CII)
1981 – 82 100
1982 – 83 109
1983 – 84 116
1984 – 85 125
1985 – 86 133
1986 – 87 140
1987 – 88 150
1988 – 89 161
1989 – 90 172
1990 – 91 182
1991 – 92 199
1992 – 93 223
1993 – 94 244
1994 – 95 259
1995 – 96 281
1996 – 97 305
1997 – 98 331
1998 – 99 351
1999 – 00 389
2000 – 01 406
2001 – 02 426
2002 – 03 447
2003 – 04 463
2004 – 05 480
2005 – 06 497
2006 – 07 519
2007 – 08 551
2008 – 09 582
2009 – 10 632
2010 – 11 711

 

How to find the Long Term Capital Gain

This is a simple, three step process.

 

Step 1: Find Indexation Factor

You need to take the cost inflation index of the year of sale, and divide it by the cost inflation index of the year of purchase to find the indexation factor.

Indexation Factor = Cost inflation index of the year of sale / Cost inflation index of the year of purchase

In our example, cost inflation index of the year of sale (FY 2007-08) is 551, and the cost inflation index of the year of purchase (FY 1988-89) is 161.

(Do not understand the difference between Financial Year, Assessment Year and Previous Year? Please read “Income Tax (IT) Jargon – Financial Year (FY), Assessment Year (AY) and Previous Year (PY)“)

Thus,

Indexation Factor = 551 / 161 = 3.42236

What does this mean? This means that the prices have increased around 3.4 times between the years 1989 and 2007!

Thus, the indexation factor tells you how many times the prices have increased between the two given years.

 

Step 2: Indexed Cost of Acquisition

This is even simpler, and intuitive as well!

The indexed cost of acquisition is actual purchase price multiplied by the indexation factor.

Login Required Download a spreadsheet illustrating the example used in this article, and long term capital gain calculation for many different scenarios.  (You need to be logged-in to download the spreadsheet. For free registration that takes less than a minute, please click here. To know the benefits of registration, please click here)

Indexed Cost of Acquisition = Actual Purchase Price * Indexation Factor

Thus, in our example,

Indexed Cost of Acquisition = Rs. 2 Lakhs * 3.42236 = Rs. 6.85 Lakhs.

 

Step 3: Find Long Term Capital Gain

Finally, the long term capital gain is the difference between the sale price and the indexed cost of acquisition.

Long Term Capital Gain = Sale Price – Indexed Cost of Acquisition

Thus, in our example,

Long Term Capital Gain = Rs. 20 Lakhs – Rs. 6.85 Lakhs = Rs. 13.15 Lakhs.

It is that simple!

So, what do you do now? Pay the long term capital gains tax on Rs. 13.15, right?

Wrong!

 

Deducting Cost of Improvements

You can even deduct the various costs incurred by you for periodic repairs of the house from the sale price. And even this can be indexed!

Let’s say you spent Rs. 75,000 on repairs of the house in May 1996.

Now, for this,

Indexation Factor = 551 / 305 = 1.80656

And the indexed cost of repair = Rs. 75,000 * 1.80656 = Rs. 1.35 Lakhs.

You get to deduct even this from the sale price!

Long Term Capital Gain = Sale Price – Indexed Cost of Acquisition – Indexed Cost of Improvements

Thus,

Long Term Capital Gain = Rs. 20 Lakhs – Rs. 6.85 Lakhs – Rs. 1.35 Lakhs = Rs. 11.8 Lakhs.

Neat, isn’t it!

Please note that if you have incurred expenditure for improvement of your house multiple times in different years, you can subtract all these indexed costs of improvement from the sale price of the house.

 

House Purchased Before 1980-1981

The cost inflation index numbers are available starting from 1980-81.

So, how do you find the indexed cost of acquisition for a house bought before 1980-1981?

Well, this is a little tricky.

In such cases, you have to arrive at the Fair Market Value of the house as on 1st April, 1981, and then find the indexed cost of acquisition based on this price.

Login Required Download a spreadsheet illustrating the example used in this article, and long term capital gain calculation for many different scenarios.  (You need to be logged-in to download the spreadsheet. For free registration that takes less than a minute, please click here. To know the benefits of registration, please click here)

 

Please also read:

- Long Term and Short Term Capital Gain – Income Tax Calculation

- How to save / avoid Long Term Capital Gain (LTCG) Tax on Sale of a House

- “Set Off and Carry Forward of Losses – Capital Gains and House Property

 

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