One of the most lucrative investments in India is to invest in properties. People constantly buy, sell, renovate and even demolish properties as per their convenience. All of these transactions have income tax implications. Whenever there is a transaction of profit that falls in an appropriate income tax slab, the profit amount becomes taxable. Today we will talk about how the capital gains tax exemption is calculated if we demolish the property. But before we do that, it's important to understand the concepts of capital assets, capital incomes, and income tax computation principles.
What are capital assets?
According to the definition, Capital Assets include the following:
- All kinds of properties owned by a taxpayer, irrespective of whether the properties are associated with the taxpayer’s profession.
- All kinds of securities owned by a Foreign Institutional Investor who has invested in those securities according to the regulations made under the SEBI Act, 1992.
Capital asset excludes the following:
- Raw materials, stocks or other items acquired for business purposes.
- Portable property owned by the taxpayer or his/her family members for personal use is not a capital asset. However, jewelry, ornaments made of expensive metals, antique works of art come under capital assets.
- Investments in Gold Bonds and other Special Bearer Bonds;
- Any agricultural land owned by a person except in the following scenarios.
- If the land is within the jurisdiction of a municipality, town area committee notifies area committee or cantonment board having a population of no less than 10000 people.
- If the land is within the following distance range measured from any municipality or cantonment board aerially:
- If the land is within 2km, and the population of the area is more than 10000 but less than 1 lakh.
- If the land is within 6km, and the population of the area is more than 1 lakh but less than 10 lakh.
- If the land is within 8km, and the population of the area is more than 10 lakh.
- Deposit certifications issued through the Gold Monetisation Scheme, 2015
Computation method for capital income:
The nature of capital assets determines the method of capital income calculation. The different types of capital assets are a short-range capital asset, a long-range capital asset. Capital income generated from the transfer of a short-range capital asset is a short-range capital income, whereas the transfer of long term capital asset gives rise to long term capital income. In case of transfer of long-range capital assets, indicated the cost of acquisition and indicated the costs of improvement are deducted from the full consideration value.
Computation of capital income tax on demolished property in India:
The methods of tax computation on capital incomes are different for properties falling under different categories. Residential, commercial, agricultural properties have their own set of computation methods.
Demolition of a property refers to the process of dismantling or completely or partially tearing down a building. Demolition can be done for various purposes like renovation, selling, rebuilding, and changing the land-use pattern.
There are several clauses within computation policies for a demolished property. Let us understand them one by one.
Suppose a taxpayer has demolished his personal residential property within three years of its purchase, to for construct a shopping complex.
Income Tax computations:
If the taxpayer has had long-range capital incomes which he invests in a residential property to claim tax exemption under Section 54F. And the taxpayer later obtains a license to demolish the residential property; he will not be allowed any income- tax exemption if he builds a commercial space on his property.
However, the purpose of Section 54F is to encourage residential space construction. Hence, if the taxpayer demolishes his residential property to build another house, or a multi-storeyed house or some houses, there will be a capital income tax exemption.
One should be careful before claiming capital income tax exemption from long-range capital incomes for investment in houses. Tax authorities carefully enquire into the purpose of demolition to examine the exemption claim. If the purpose of the demolition is to construct a non-residential or commercial space, then there would be an income tax computation according to the standard rules of capital income tax. However, there can be several situations in which demolition of a residential property would be tax exempt. All these things like changing the layout and restructuring come under it.
Let us take an example to understand the process of computation:
Suppose Meenal has inherited a house in Bangalore. Since the house was old and dilapidated, she decides to sell it. To get a good price of the property, she decides to demolish the old house and rebuild it. She will have to pay the rebuilding amount. Now, she is concerned as to what will her capital income be considered, a long-range or a short-range capital income and how will the tax be calculated. Let us help Meenal resolve her concern
Since the land is taken as a long term asset, the rebuilding will also be long term Asset. Rebuilding cost will be indexed only of 2018. But the property will be considered as long term.
Cost Indexing is done based on the 2001 market value of the old house. Therefore, the cost of the house along with the rebuilding cost will become the total cost. While the old fair market value is indexed on the basis of the index of 2019 divided by 100, the cost of rebuilding along with demolition charges will not get any indexation since its sale will be in the year of construction.
Therefore, capital income in 2019 will be Sale Price LESS 2001 Fair Market Value x CII of 2019 ÷ 100 PLUS Cost of rebuilding.
Another important point is that, in case of an inheritance, the cost of acquisition will be the prince for which the previous owner who was the original owner had bought it. If the real owner before1st April 1981there acquired the property is an option of taking the actual acquisition cost or FMV of the property as on 1 April 2001 whichever is higher. The cost involved in the demolition and rebuilding of residential property is considered as the improvement cost and gets added to the cost of acquisition.