While the tax rate has been cut, the government has removed the indexation benefit.
What is indexation? Indexation adjusts the purchase price of an asset for inflation, thereby reducing the gains and ultimately the tax liability.
Additionally, the finance minister clarified that property values indexed up to 2001 are grandfathered for capital gains purposes.
This means that the removal of indexation benefits will not apply to properties held before 2001, which will continue to enjoy these benefits.
If you bought property before 2001, the base year for the cost of acquisition will be 2001.
For properties purchased after 2001, the actual cost of acquisition will be considered.
Short-term capital gains will continue to be taxed at the slab rate. These changes will take effect from July 23, 2024.
This raises the question: is this beneficial for home buyers and sellers? Could it deter buyers from purchasing homes for investment purposes? While the government suggests the effective tax rate will benefit home buyers, analysis suggests otherwise.
This move will not impact those who sell a house and reinvest in a new one, as they can offset past capital gains from the sale of the old house against the purchase of a new home within two years, as per Section 54 of the Income Tax Act.
But what about those who invest in assets other than property or do not reinvest the money at all? This is where it gets tricky.
An analysis by CLSA indicates that the change will impact relatively short-term investments where market price growth is less than 10%.
However, for investments with a longer holding period (over ten years) and where property price appreciation exceeds 10% per annum, the impact of this new regime would be neutral or marginally beneficial.
Real estate taxes under old regime
| Holding Period | 5 | 10 | 20 |
| Cost of Acquisition | 100 | 100 | 100 |
| Indexed Cost of Acquisition | 126 | 151 | 321 |
| Tax rate | 20% | 20% | 20% |
| Tax on Price increase at 5% CAGR | 0.4 | 2.3 | -11.2 |
| Tax on Price increase at 7.5% CAGR | 3.6 | 11 | 20.7 |
| Tax on Price increase at 10% CAGR | 7.1 | 21.6 | 70.3 |
| Tax on Price increase at 12.5% CAGR | 10.9 | 34.7 | 146.7 |
Real estate taxes under new regime
| Holding Period | 5 | 10 | 20 |
| Cost of Acquisition | 100 | 100 | 100 |
| Indexed Cost of Acquisition | 100 | 100 | 100 |
| Tax rate | 12.5 | 12.5 | 12.5 |
| Tax on Price increase at 5% CAGR | 3.5 | 7.9 | 20.7 |
| Tax on Price increase at 7.5% CAGR | 5.4 | 13.3 | 40.6 |
| Tax on Price increase at 10% CAGR | 7.6 | 19.9 | 71.6 |
| Tax on Price increase at 12.5% CAGR | 10 | 28.1 | 119.3 |
Analysts note that markets like Bangalore, Hyderabad, and Pune, which are driven by end-users, will be the least impacted. In contrast, markets like NCR and Mumbai, with higher investor activity, are likely to be adversely affected.
Homebuyers, particularly investors, who previously used property sales to offset capital gains tax burdens, may reconsider their purchasing decisions due to the removal of indexation benefits, potentially dampening sales velocity temporarily.
Ambit suggests that the lower long-term capital gains tax rate may incentivize short-term property investments, as potential returns could outweigh the loss of indexation benefits.
According to a housing price tracker report by the real estate lobby CREDAI and data analytics firm Liases Foras, average home prices in top Indian cities have risen about 20% in the last two years.
This increase includes a 31% rise in Bengaluru, 30% in Kolkata, 32% in Delhi NCR, 2% in MMR, and 26% in Hyderabad.
This surge follows the significant turnaround in the real estate cycle post-COVID.
Before this, the industry faced a lull in demand and pricing. The indication now is that home prices might remain subdued, between 5-7%.
Gulam Zia, Executive Director at Knight Frank India, has weighed in on the implications of these changes.
He pointed out that the annual return on property prices has been around 7-8%, which challenges the finance secretary’s assertion that the effective tax rate will be lower if property prices rise by more than 11%.
According to Zia, it has been a long time since the sector experienced such a significant surge in property prices.
Zia also expressed skepticism about the government’s claim that the effective tax rate on property sales will be lower due to the new tax rules.
He stated that double-digit returns adjusted for inflation in the real estate market are unrealistic.
He noted that only a small percentage of buyers—about 15-20%—purchase properties for investment, while the majority buy for personal use.
In some projects, investors have entered the market due to price increases exceeding 10%, but this is not common.
Zia also highlighted that over the past three years, average property prices have grown by 7-8% per annum.
Before this period, the market experienced a significant decline.
Despite the challenges posed by the new tax rules, Zia mentioned that buyers in Maharashtra are still purchasing properties, even while paying a 6% stamp duty, leading to record-breaking registration numbers.
Catch all Budget related updates here