Owning a home in India is not merely a financial decision, it is an aspirational and emotional issue that represents a significant personal milestone and is a measure of success. Most Indians will invest in a home as soon as they can afford the down payment and equated monthly instalment (EMI). They also aspire to trade it up every few years, as their income grows. We buy a property to live in, even though hard-nosed calculations suggest that renting is cheaper and appreciation of property value is meagre, after costs and taxes.
Over the decades, various governments have encouraged this aspiration with a steady increase in tax exemptions on interest payments and repayment of principal. On selling a property, the income-tax law offered indexation which allowed the original cost of property to adjusted upwards with inflation for calculating capital gain. So when the Union Budget eliminated the benefit of indexation on property, it unleashed extraordinary outrage, especially among over-taxed and long-suffering middle class Indians. This happened without a clear understanding of the issue.
“Everyone is an indexation specialist tonight,” smirked the head of Bharatiya Janata Party’s (BJP’s) information technology (IT) cell on social media, only to delete his post after his Party veterans, chastened by the recent election results, advised against trolling citizens and appearing to be ‘arrogant’ and ‘tone deaf’.
A closer look at the decision to scrap indexation suggests that the finance minister (FM) might not need her army of supportive ‘influencers-trolls’ to defend at least this aspect of the Budget.
Top realty experts in Mumbai are unanimous that eliminating indexation on realty will indeed lead to higher tax payments for a small number of people, but the overall impact may actually be positive in the long run. Advocate Anil Harish points out that the abruptness of the change, without a transitional phase or a grandfathering clause, poses challenges, particularly for those involved in ongoing financial transactions (Read his analysis of indexation here: How Change in Capital Gains Tax Affects Sale of Your Property). Although the impact of scrapping indexation is limited, the lack of consideration for people has been a hallmark of policy-making of the past decade, whether it is demonetising currency or imposing a sudden lock-down during COVID, or forcing buggy software on us for statutory reporting and tax payments that carry heavy penalties on reporting delays.
What Is Indexation in Real Estate?
To understand the implications of this policy, it's crucial to first grasp what indexation in real estate means. Capital gains are calculated as the difference between the sale price of a property and its purchase price. The indexed cost of acquisition adjusts the purchase price for inflation, as determined by the government's cost inflation index, thus reducing the taxable gain on sale. Long-term capital gain is the difference between the sale price minus indexed cost of acquisition for a long-held asset.
On 23 July 2024, the government amended the rules to scrap the benefit of indexation for calculating long-term capital gains (LTCG) with immediate effect. At the same time, it reduced the tax payable from 20%+ to 12.5%+. This change to a flat rate simplifies the tax computation process and aligns the tax treatment with other asset classes that have no indexation option. The government has also clarified that properties purchased before 1 April 2001 will be subjected to the old indexation system. Pranay Vakil, chairman of Praron Consultancy (India) Pvt Ltd also notes that “those moving from one house to another (bigger one) are not affected by the change, so long as their capital ‘gains’ do not exceed the cap of Rs10 crore introduced last year.” Based on certain interpretations, Mr Vakil says, this can actually apply to two properties owned by an individual. So all those who plan to swap existing apartments for newer ones are unaffected. Mr Vakil divides property-owners into two categories – those who ‘invest’ in realty and those who buy assets for their own use. He, and other realty experts agree with the finance ministry that the majority home-owners, buying properties for their personal use, will remain unaffected. The question is: Who will be affected by this change?
Who Are the Losers?
Essentially, it is wealthy individuals who buy real estate as an investment. These are also of two types – those who hold on to property for a long time because sharp price appreciation made up for high costs (such as stamp duty, registration, legal fees, brokerage and ongoing costs for building maintenance/ society charges, repairs and payment of utilities) and those who are early investors in large projects, coming in at a discounted price and looking to cash in immediately on completion of the project. The new indexation rules will make such investments unattractive.
Pankaj Kapoor, managing director of Liases Foras, a leading real estate research company, illustrates the situation with a specific PIN code (400026) example in Mumbai (image below). The average price in this area (Prabhadevi-Worli) rose from Rs59,601/sqft (square foot) in 2009 to Rs86,204 in 2024 - appreciating at a compounded annual growth rate (CAGR) of just 2.4% over 15 years. The inflation index value which was 148 in 2009 rose to 363 in 2024. Inflation increased at a CAGR of 5.8% during the same period. An investor caught in this situation would have suffered a loss by the indexation method. He will have to pay 12.5% tax now on the meagre annualised gain of 2.4%. “Since investor activity was very high in the 2006 to 2016 period, such investors ended up making a wrong speculative bet – they bought high, earned a return that was lower than inflation, but there is no escaping capital gains tax,” he says. For these investors, realty as an asset class has lost its appeal.
The policy change in this budget also addresses a broader issue in India's housing market: speculative investment that contributes to housing shortages and rising prices in urban areas. India has historically used its tax policies to steer investment to specific asset classes. By removing indexation for these investments, the government aims to discourage speculative buying, thereby increasing the availability of housing stock and stabilising prices which could benefit many prospective home-owners. Remember, most properties that are purchased as pure investment remained locked up because enforcement of rent agreements remains risky in India.
As India continues to evolve its economic policies, the real estate sector will need to adapt to these changes, balancing the aspirations of home-owners with the realities of market dynamics. The decision on indexation may have triggered initial outrage, but it would lead to a more stable and equitable housing market, benefiting a larger portion of the population in the long run.
Comments
pushpa_s
2 months ago
Like the IT tweet, the govt should not jump the gun. Rationalising the reason and explaining the pitfalls of indexation ( how rich game the system) like you have done would stop all the unwarranted fear in SM. Demon also could have been explained better and if really wanted to help poor could have put a limit of 50 k that could be changed without proof for 6 months. More control on cash transaction limits of 10k usd in rich purchases is another way to curb black money. Best way would be to come heavily on corruption at lower levels, say aadhar chgs, regn, licences etc etc. msg will go up that govt is serious on corruption, not fire at a big target and scoot without reaching the logical end. Recent case of gst on infosys
Removal indexation benefit though justifiable from the angle of equitable housing and market stability , the timing of announcement of such a policy at this juncture when the people have not come out of the pandemic shock, continuous inflationary pressures, unemployment problems, high tax rates on incomes, Fuel costs, GST almost on all items one can imagine and that too at even 28% on items consumed by even low income groups is really a shock which could and should have been sensibly, intelligently and logically avoided. The FM has presented her 7th Budget and all her previous six budgets have been by and large welcomed for their contribution to consolidate fiscal position of the Government successfully although at the cost of incurring the wrath of the middle class people in particular, as the Seniors lost most of the concessions they enjoyed and have not got any tax benefits other than some tinkering benefits cleverly managed without even raising the tax exemption limit from 2.50 lakhs available in the year 2014 when this Government took over the power. While fiscal management has been exceptionally good but the economic, and social management leaves ample scope for improvement. Technology has been optimally used but optimisation of benefits from the technological advancement has not been even attempted is a sad reflection on the over all poor governance of the entire economy. The people do not seem to be happy with all sorts of taxes on anything and everything and the very thought of various levies only irritates and irks them. The latest budget may have long term benefits to the economy, but the people who have to take care of day to day life out of their hard ways of earning find the approach of the Government is a bit harsh is the ground reality.
Ma'am your statement there that the government has clarified that property bought before April 1, 2001 will be subjected to the old indexation system needs more elaboration. It is not the case now that they get the earleir benefit of indexation, I assume that, what govt officials clarified is that they can use the higher of the stamp duty value as on 01-04-2001 or the FMV (not higher than stamp duty value) or the purchase price whichever is higher as their cost price.. the tax will be 12.5% only. And they don't get to index the purchase price when they sell..isn't that the interpretation after the budget.
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