Tax on inherited property

Balwant Jain 

There is widespread confusion about taxation surrounding an inherited property. In this article I will discuss various issues related to taxation on inherited property.

Taxation on annual basis

Every person who owns a property is taxed under the head “Income from house property” on annual basis. The basis of taxation is annual value of the property which in turn is derived from the rent received or reasonable rent for which the property is expected to fetch. In respect of the only one self-occupied house property, the annual value is taken as nil. For let-out property, the value of annual rent received is taken as “annual value” generally.

A standard deduction @30% of the annual value/rent received is allowed in respect of let-out property or additional self-occupied properties where notional rent is offered for tax. Since the annual value of one self-occupied house property is nil, no deduction is effectively available in respect of repairs.

In addition to the deduction for repairs, you are entitled to deduction for interest paid to purchase. So in case you have inherited the property without any outstanding loans, you will not get any deduction for interest.  However, in case any money is borrowed by you for repairs, renovation etc of the inherited property, you will be entitled to get deduction of up to Rs 2 lakh in case such loan is taken after April 1, 1999.

Taxation on sale of property

People believe that money received on sale of an inherited house is fully exempted from tax. This is not correct. Yes, any asset received as inheritance is fully exempt from gift tax but amount on sale of such asset is not exempted from tax. It will be taxable under the head capital gains.

The capital gains may be short term or long term depending on the period for which the asset was held. In case the inherited property is held for more than 36 months, it is considered as long term. While calculating the holding period of the house inherited by you, the period for which it was held by the previous owner is also to be added to your holding period.

Long-term capital gains are calculated by deducting the cost of acquisition of the assets as enhanced by the cost inflation index applicable based on the year of purchase and year of sale. You are also entitled to deduct cost of improvement of the house as indexed with reference to the year of such improvement.

Since you have got the house as inheritance, you will think that whole of the money received by you will be taxable in your hand as you have not incurred any cost. The legal position is not so. So for arriving at the cost of acquisition, the value to be taken will be the amount any of the previous owners has paid for it. For example, in case you inherited the house from your father and he had inherited the same from his father and your grandfather had purchased it for Rs 50,000, then the amount paid by your grandfather shall be considered as the cost of acquisition for capital gains purposes. However, in case the asset was inherited by you before April 1, 1981, you have the option to substitute the fair market value of the property as on April 1, 1981, for the cost of acquisition. So in case the asset is inherited by you after April 1, 1981, you will have to take Rs 50,000 as the cost of acquisition but apply the indexation with reference to the year in which you inherited it as per the strict legal reading of the provisions of law. However, there are various decisions of few high courts, including Mumbai, Delhi and Gujarat where the courts have held that in respect of inherited property, taxpayer will not only be entitled to substitute the cost paid by any of the previous owners in case the asset is acquired after April 1, 1981, but also the taxpayer shall be entitled to get the benefit of indexation from the year in which that previous owner had acquired the house. In any case if the asset was purchased prior to April 1, 1981, you still have the option to substitute market value as on April 1, 1981, but also get the indexation benefits from April 1, 1981, though you might have inherited the same later on.

Exemption from long-term capital gains

So do you have to pay tax on the long-term capital gains calculated as above or can you save it? Yes, you can save the taxes. What you have to do is either buy one house within two years from the date of sale of the inherited house or construct one house within a period of three years. The amount of money required to be invested in another house is only the indexed long-term capital gains as computed above and not whole of the sale value.

You have to utilise the capital gains before the due date of filing of your income tax return, failing which you need to deposit the unutilised portion of the capital gains in capital gains account scheme with an approved bank. Alternatively or additionally you can buy capital gains bonds of either Rural Electrification Corporation or National Highways Authority of India within six months from the sale of the inherited house. Please note that the maximum amount of investment you can make is only Rs 50 lakh for saving capital gains tax. 

From the above, it is clear that taxation provisions of inherited property are different than normal property.

The author is Company Secretary of Bombay Oxygen Corporation Limited. The views expressed in this article are his own