Factor in capital gains

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Across Mumbai, several families are looking towards the redevelopment of their old tenanted property whereby they get a chance to move into a larger apartment with modern amenities. These properties have been granted higher floor space index (FSI), which is why developers are queueing up amid the lure of high returns.

These dream homes, however, have one grey area: how does one calculate the capital gain in such a case, and the tax thereon? With redevelopment of such properties being touted as a solution for renewing urban spaces, this is an issue that could confront a large number of families across the country.

Capital Gains

“It is calculated when a capital asset — in this case the residential property — is transferred. The transfer includes sale or exchange of property or relinquishing rights to it. If the property is held for less than three years, the gain is short-term and if it is held more than three years then it is long-term,” according to Vinod Sampat, an advocate and property expert.

Let us suppose a buyer bought a flat in in 2001 at Rs 40 lakh. He sold the flat in 2011-12 at Rs 86 lakh. In this case, the capital gain is not Rs 46 lakh (the gain from the transaction), for the buyer has not factored in cost indexation.

Indexed Cost

This concept applies only for computing long-term capital gain. In the above case, the value is Rs 12,29,108 and not Rs 46 lakh (see box), and the capital gains tax is charged at around 20 per cent of this amount. How?

Since the time gap between sale and purchase is over three years, indexation comes into play. The government has declared a year-wise table of Cost of Inflation Index (CII) to adjust original purchase or sale cost as per the inflation presumed in that year of purchase or sale. This CII table is available with professionals such as chartered accountants, valuers, advocates etc.

This index has been computed taking the financial year 1981-1982 as the base year, at which the index has a value of 100. Properties purchased before this year will also have an index value of 100.

Tenanted Property

In the current context, ‘tenanted’ refers to the property taken from the landlord on rent, almost permanently. “This is neither a long lease nor a leave and licence arrangement. There is a lump-sum down payment called Paghadi,” says Sampat.

In Mumbai for example, lakhs of properties in south and central Mumbai are tenanted even to this day. “As per Bombay Rent Act, it was illegal to take or pay Paghadi. However, as per Maharashtra Rent Control Act, 1999, Paghadi has become legal,” says Vimal Punmiya, a tax consultant. Barring a few official Paghadi transactions after 1994, most properties have no proof of this payment.

Taxing Redevelopment

Let us take the example of a family that moved into a 200 sq ft room in 1966 as a tenant on Paghadi basis in the Opera House area of south Mumbai. In 2010, the landlord and the family signed an agreement to redevelop the property. The family agreed to give up the right of tenancy and get a 300 sq ft flat in return — now their own.

Some consultants say that in this case, the fair market value of the room as on April 1, 1981 should be calculated to determine acquisition cost and capital gain.

“The fair market value is calculated as per the Ready Reckoner rate of 1981. For the given location, the maximum is around Rs 1,200 per sq ft. Let us suppose the room is on the first floor without a lift and a view, one can consider the value at Rs 1,000 per sq ft, which makes it Rs 2 lakh. Usually the share of the landlord is 33 per cent and that of the tenant at 67 per cent, or Rs 1.34 lakh,” says Praksah Balu, a property valuer.

So, the indexed cost of acquisition would be Rs 1.34 lakh (fair market value) multiplied by CII of 2010-11 divided by CII of 1981-82. According to the table, the CII of 2010-11 is 711, and of 1981-82 is 100, which makes the cost Rs 9,52,740.

The market value (cost of sale) of the new 300 sq ft flat in 2010 (the year of capital gain) would be at least Rs 72 lakh. The capital gain would be Rs 72 lakh – Rs 9,52,740, i.e. Rs 62,47,260. The capital gains tax, at around 20 per cent of this amount would be Rs 12.5 lakh — a substantial burden on the erstwhile tenant.

Punmiya counters this from a taxation perpective. “If the (Paghadi) transaction (cited here) is prior to 1994, and no money is paid officially, then cost of acquisition will be taken as zero. If there is no cost, there is neither fair market value nor indexation. If the tenant intends to stay in the new house, technically purchased as per Section 54F of the Income Tax Act (related to capital gain), then he is not liable to pay capital gains tax.”

The tenant should get the redeveloped house within three years of giving up possession to avoid crossing the three-year time frame of Section 54F. “He will not be able to transfer the new flat for the next three years for exemption under long-term capital gain. Any sale/transfer in future will attract capital gains tax,” says Punmiya.

He adds that official Paghadi transactions after 1994 will be subject to capital gains tax, allowing for fair market value and cost indexation (like that calculated above).

Punmiya advises tenants to have all documents such as agreements, purchase deed, completion certificate etc to justify exemption to the tax authorities. In case of substitution of fair market value, the valuer’s report must be obtained, preferably before demolition.


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