With inflation eating into your income each day, have you been wondering whether it could dig into your taxes as well? There is a way by which you can reduce your taxes on assets and investments held for long-term.
One can adjust the purchase cost of real estate, mutual funds, shares and gold by a method called indexation.
Indexation is nothing but adjusting the cost of asset or investments in view of the inflation. This adjustment is done from the date when the investment was made, upto the period it finally matured or was sold.
So, by increasing the cost of purchase through indexation, you reduce the actual profits and thereby the tax to be borne on the increase in asset value also called capital gain.
One cannot just adjustment for inflation according to the inflation you perceive, but it has to be done using the Cost Inflation Index (CII) declared each year by the government.
You need to calculate the indexed cost of purchase using:
(Cost of purchase x CII of year of sale) / (CII of year of purchase)
So, if you invested Rs 10 lakh in a property in 1998 and sold it at Rs 80 lakh in April 2014, your gain isn’t Rs 70 lakh. The gain would be benchmarked against the indexed cost of Rs 10 lakh, which turns out to be Rs 30.93 lakh.
So the total gain when the property is sold at Rs 80 lakh is Rs 49.06 lakh and not a flat Rs 70 lakh as one would quickly calculate on the back of an envelope.
Similarly, cost of other assets too can be adjusted for inflation and this may also result in negative returns, thus eliminating the tax liability completely. But investments such as fixed deposits cannot be indexed.
Remember, that the tax rate under certain assets changes depending on whether you opt for indexation benefit. Either one pays 10.30% tax without indexation or 20.60% tax with indexation benefits. There is no long term capital gains tax applicable on equities.
To save capital gains tax one can invest in capital gains bonds issued under Section 54EC such as NHAI or REC, within six months of selling the asset or investments. With respect to real estate purchase of another property within two years too can help you save additional tax.
|Year of Purchase||1998|
|Year of Sale||2014|
|CII of 1997-98||331|
|CII of 2014-15||1024|
|Indexed Cost of Purchase [(a x f)/e]||3093656|