Starting from July 23rd, 2024 the change from a 20% LTCG tax rate with indexation benefits to a 12.5% rate without indexation could significantly raise your tax liability from property sales, particularly for those with modest investment appreciation. Investors and property owners must now navigate a scenario where tax implications may overshadow the benefits of modest market gains.
The Income Tax Department reports nominal real estate returns of 12% to 16% annually, while the government cost inflation index shows an inflation rate of 4% to 5%. Despite promises of “substantial tax savings” from recent tax changes, data from Knight Frank and the RBI Housing Price Index reveal compound annual growth rates (CAGR) in real estate of only 1% to 7% over the last two, five, and ten years. Although some regions may see high returns, overall market trends are subdued. Consequently, the revised tax structure might benefit those with high short-term gains but could increase tax liabilities for long-term investors who previously enjoyed indexation benefits.
Old vs. New Structure
Under the old tax structure, LTCG on real estate was taxed at 20% with indexation, which adjusted the purchase price for inflation. The new tax imposes a flat 12.5% LTCG rate without indexation, resulting in higher tax liability. However, properties held before 2001 will be valued at their fair market value as of April 1, 2001.
If you buy a property for ₹100 and it appreciates at 5% annually over two years to ₹110, the inflation-adjusted price using the Cost Inflation Index would be ₹109.6. Under the old tax structure, the tax would be ₹0.10, but under the new structure, it would be ₹1.30, a 1000% increase.
For a 20-year holding period, the inflation-adjusted price would be ₹321, resulting in a long-term capital loss of ₹55.90. The old regime allowed offsetting this loss against other capital gains for up to 8 years, while the new regime taxes all scenarios. The new structure impacts short-term investments (less than 5 years) with market growth below 10% per annum but is neutral or slightly beneficial for investments held over 10 years with appreciation above 10% per annum.
Impact of New Tax Structure on Real Estate Investments
You can save taxes under Section 54EC by investing up to ₹50 lakh of capital gains in specified bonds and up to ₹10 crore under Section 54 by buying or constructing a house. The new tax structure won’t affect end users who reinvest in new properties but will impact real estate investors looking to profit and invest elsewhere. The abolition of indexation and changes in reporting rental income will limit deductible expenses, increasing taxable income and reducing overall returns. These changes will limit the expenses investors can claim, increasing their taxable income and tax liability, thereby reducing returns from investments. This could deter investors who purchase properties solely for rental and capital appreciation returns.
Despite the tax changes, real estate prices are expected to be driven primarily by demand and supply rather than tax considerations. The impact of these changes on demand will become clearer as the remainder of the fiscal year unfolds. Real estate remains a solid investment, but don’t expect sky-high returns given the current market and new tax rules. It’s still a good bet, but if you’re looking for impressive gains after inflation, you might want to consider equities instead.
