As soon as finance minister Nirmala Sitharaman announced during the union budget that LTCG (Long Term Capital Gains) would be reduced from 20% to 12.5%, the stock market took a hit. While the immediate analysis seemed to indicate that the LTCG hike would adversely affect the stock market in the short-term but big pocket investors wouldn’t be affected as much as presumed; the seasoned financial analysts pointed out that the sector that would be hit badly – was in fact real estate.
Prima facie what looked like the LTCG being lowered from 20% to now 12.5%, has in fact hurt the property market the most. Reason: the indexation benefit under Section 48 that is presently available for property, gold, and other unlisted assets, have now been proposed to be removed.
Let’s illustrate the combined impact of reducing the LTCG rate and eliminating indexation over a 25-year holding period.
Scenario I:
Purchase Price: Rs 1,00,00,000
Sale Price after 25 years: Rs 5,00,00,000
Inflation Rate: 5% annually
Before Changes (with Indexation):
Indexed Purchase Price: Rs 1,00,00,000 (1 + 0.05)^25 ≈ Rs 3,38,63,225
LTCG: Rs 5,00,00,000 – Rs 3,38,63,225 = Rs 1,61,36,775
Tax at 20%: Rs 1,61,36,775 = Rs 32,27,355
After Changes (without Indexation):
No Indexation: LTCG = 5,00,00,000 – 1,00,00,000 = 4,00,00,000
Tax at 12.5%: Rs 4,00,00,000 = Rs 50,00,000
Watch this video to learn more about how indexation and LTCG affects real estate. Keep in mind that this scenario is based on 11% CAGR and 5% inflation. With different CAGR, the outcomes will be different.
Naushad Panjwani, chairman of finance, Corporate and Allied Laws Committee of Bombay Chartered Accountants’ Society, finds a bigger worry in the present scenario. He questions, what if one has to sell their house in case of some emergency, like a medical emergency in the family, and one has no option but to sell it at a lower than the market price. “Can you imagine the losses an average middle-class man will have to suffer in this case? There is also the issue of circle rate anomaly and in many places, the circle rate is way higher (due to new luxury supply in the market) than the actual market rate for the old buildings. What will a buyer do in such a case? It is a double whammy because first, he will have to settle stamp duty at a higher price and then again will be assessed by the Income Tax at a higher rate. Isn’t it an injustice? Won’t it further encourage more cash transactions in many cases,” questions Panjwani.
Rikky Dua, a corporate tax consultant, categorically calls the removal of indexation benefits as worrisome. According to him, while affordable housing was already under a lot of stress, now the investors won’t find even luxury housing investment lucrative. “In my honest opinion, the removal of indexation with LTCG, added with the lower excise duty on gold, will encourage an average Indian to go for investment with gold. Now, the problem is that gold, however lucrative, is a dead investment. At least investment in real estate and stock market brings liquidity into the market and revitalises the economic cycle,” says Dua.
Multiple reactions can be seen on social media questioning the rationale of a ‘one-size-fits-all’ solution of 12.5% LTCG without indexation. D Muthukrishnan, a certified financial planner, calls it a ‘disastrous budget’ on X. According to him, what is relevant for investors: Long-term capital gains for all asset classes are going to be 12.5%. You may worry about your stocks and equity funds. Actually, that is the least of your concerns. You pay 2.5% more than earlier now. What is important is that the same rate is going to be applicable for all the asset classes, including gold and real estate.
“In real estate, you’ve been paying a tax of 20% with indexation. That’s why you were paying less tax. Now the rate is going to be 12.5%. Is it not time to celebrate? No. Indexation benefits have been removed for all asset classes, including real estate. You were able to adjust your purchase price to inflation and then pay tax. Now that is not possible. The tax outflows on sale of real estate would be henceforth huge, very huge,” writes Muthukrishnan.
Vaibhav Gupta, partner, Dhruva Advisors, also points out the changes that have been announced on capital gains taxes. He says that while long-term capital gains taxes have been reduced for residents on unlisted shares and real estate, it is interesting to note that the long-term capital gains tax for non-residents on unlisted shares has been increased from 10% to 12.5%. This will clearly impact the returns of FDI investors. Removal of cost indexation on all assets is a very significant change which will impact real estate returns in a big way! At the same time, for Indian promoters wanting to sell their unlisted businesses, the reduction in the tax from 20% to 12.5% is a very welcome change. It brings listed and unlisted share sales at par.
“The other important change is that any capital gains on bonds and debentures will also be treated as short-term capital gains, which shall be taxed at the applicable tax rates. While changes in buyback were anticipated, however treating buyback as a dividend and allowing capital loss of the cost of purchase to the shareholders is likely to reduce the attractiveness of a buyback. Reducing the holding period to two years for long-term capital gains should be a big positive for the real estate sector. Lastly, the taxability of share transfer in an offer for sale has been clarified to provide that the cost offset will be based on indexation till FY2018, which brings this at par with the sale post listing,” points out Gupta.
Housing.com POV
The LTCG reduction without indexation is evidently a dampener for investment instruments like the stock market and real estate. While the stock market investor, often making returns in the range of 14-20%, may bear the jolt, real estate investors with a national average return of 7-8% have a real reason to worry.
As far as budget-constrained middle-class home buyers are concerned, for whom real estate is usually the only social security, the removal of indexation benefits means a house purchase could become a loss-making proposition moving forward.
(Authored by Ravi Sinha, CEO, Track2Realty)
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