Decoding Flexible Tax Regime for Long-Term Capital Gains on Real Estate, Balances Investor Interests

By Megha Maan, Director – Research & Consulting, Savills India

Mumbai / September 25, 2024: Among the significant announcements in the Union Budget for the fiscal year 2024-25, one key change centered around the tax treatment of long-term capital gains (LTCG)  from the sale of immovable properties, including real estate assets. 

The budget initially proposed the removal of indexation benefits for properties purchased or inherited after 2001 and reduced the LTCG tax rate from 20% to 12.5%. With this announcement, the goal was to streamline the tax system and create a more equitable approach, ensuring that all asset classes and investors are treated equally.

In response to the concern raised to the original proposal, and to address the potential slowing down of resale market the government introduced an amendment allowing taxpayers the option to choose between the new and old tax regimes, selecting whichever results in a lower tax liability. The grandfathering clause, which allows the indexation benefit to continue to be applicable to the properties acquired before April 1, 2001, is welcomed by the industry and the stakeholders.

A comprehensive understanding of the proposed tax regime change would require examining the interplay between the holding period of the property and the price multiple (sale price as a multiple of the acquisition price). We have taken a deep dive into these dynamics, highlighting key considerations and potential outcomes. The article aims to unravel the implications on real estate transactions and evaluate the effectiveness of the two systems.

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Holding Period vs. Price Multiple: A Qualitative Exploration

A range of iterations and various combinations of holding periods  and price multiples  reveals ‘points of indifference’ where the tax liabilities under the old and new systems are equivalent. Depending on these variables, either the old or new tax system may be more advantageous for the taxpayer.

For investors holding properties over extended periods, the removal of indexation can have a significant impact, making the new tax system more efficient at higher price multiples as the holding period increases. For instance, the illustration below demonstrates the tax liability when a property is sold after being held for 9 years. In this case, at an assumed price multiple of 2.25 (Scenario 1), the tax levied under the new system will be lower.

On the other hand, if a property is sold after 21 years at an assumed price multiple of 6.5 (scenario 2), the tax levied under the old system with indexation will be more favourable. However, if sold at a higher price multiple of 7.5 or above (Scenario 3), the new tax system becomes advantageous. This is because the indexed capital gains (i.e. the base value considered for tax computation) under the old system increase significantly and are taxed at a higher rate, whereas the unindexed gains under the new system are taxed at a lower rate. Ideally, if the property’s value increases more than the inflation rate, the new LTCG tax rate system is expected to be more beneficial compared to the previous old LTCG tax rate system with indexation.    

For longer holding periods with high price multiples, the new system may result in a lower tax burden due to the reduced tax rate. On the contrary, it may potentially increase the tax liability, particularly for properties held for shorter periods with relatively moderate price appreciation. 

The amendment to the original Finance Bill is a positive development, reflecting a willingness to consider industry feedback. Offering the flexibility to choose between the new and old tax regimes—either a 12.5% LTCG tax without indexation or a 20% LTCG tax with indexation for transfer of properties acquired before July 23, 2024—is expected to encourage more cautious and strategic decision-making among long-term investors with moderate or significant property appreciation. 

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Overall, this amendment demonstrates a sophisticated approach to tax policy, underscoring the government’s commitment to sustaining a balanced and investor-friendly environment. By promoting greater flexibility and encouraging thoughtful investment strategies, the government is poised to foster continued growth and stability in the real estate sector.