The acquisition of capital assets through inheritance or bequest is a common event that has specific implications under capital gains tax rules. In India, the taxation of capital gains on inherited assets is governed by Section 49(1) of the Income Tax Act, 1961. This section outlines how the cost of acquisition is determined and how the capital gains tax applies when the inherited property is later sold or transferred.
In this blog, we will explore the key provisions of Section 49(1), discuss how capital gains tax is calculated on the sale of inherited assets, and highlight important considerations for taxpayers.
What Does Section 49(1) Say?
Section 49(1) of the Income Tax Act deals with the cost of acquisition of capital assets acquired through inheritance or bequest. According to this section:
- When an individual inherits an asset, the cost of acquisition is not the value at the time of inheritance. Instead, the cost of acquisition is deemed to be the cost at which the previous owner acquired the asset.
- The holding period for determining whether the capital gain is short-term or long-term is also not reset. The holding period of the deceased person is considered for the purpose of calculating capital gains tax.
Key Provisions Under Section 49(1):
| Provision | Details |
|---|---|
| Cost of Acquisition | The cost of acquisition for the person inheriting the asset is the cost at which the previous owner acquired the asset. |
| Holding Period | The holding period of the deceased person is considered for calculating capital gains tax, even though the asset is now held by the inheritor. |
| Capital Gains Tax | Capital gains tax is applicable when the inherited asset is sold or transferred, with the cost of acquisition and holding period determined as per Section 49(1). |
How Does Capital Gains Tax Apply to Inherited Assets?
When an inherited asset is later sold or transferred, the capital gains tax is calculated in the following manner:
- Determine the Cost of Acquisition: The cost of acquisition is not the market value at the time of inheritance. Instead, it is the price at which the deceased person acquired the asset.
- Determine the Holding Period: The holding period of the asset is not reset. The number of years the deceased person held the asset is considered when calculating whether the gain is short-term or long-term.
- Calculate Capital Gains: The capital gain is calculated as the difference between the sale price of the asset and the cost of acquisition (as per Section 49(1)).
Example of Capital Gain Calculation for Inherited Assets
Let’s consider an example to understand how capital gains tax applies to inherited assets:
| Details | Amount (₹) |
|---|---|
| Sale Price of Property (Inherited) | ₹50,00,000 |
| Cost of Acquisition by Deceased Person | ₹20,00,000 |
| Holding Period of Deceased Person | 15 years |
| Capital Gain | ₹50,00,000 – ₹20,00,000 = ₹30,00,000 |
Step 1: Determine Cost of Acquisition
- The cost of acquisition is ₹20,00,000, which is the amount the deceased person originally paid for the asset.
Step 2: Holding Period
- Since the deceased person held the property for 15 years, the holding period is also considered 15 years for the inheritor.
Step 3: Calculate Capital Gain
- The capital gain on the sale is ₹30,00,000 (₹50,00,000 sale price – ₹20,00,000 cost of acquisition).
Tax Treatment Based on Holding Period
One of the key aspects of capital gains tax under Section 49(1) is the holding period of the asset. The holding period of the asset is essential for determining whether the capital gain is short-term or long-term.
- Short-Term Capital Gain (STCG): If the capital asset is held for less than 36 months (for immovable property) or 12 months (for listed shares), the gain will be treated as short-term capital gain and taxed at the applicable short-term rates.
- Long-Term Capital Gain (LTCG): If the asset is held for more than the prescribed period (36 months for immovable property or 12 months for listed securities), it qualifies as long-term capital gain, and the gain is taxed at the long-term rates.
Since the holding period of the deceased person is considered, inherited assets typically qualify as long-term capital assets, even if the inheritor has not held them for long.
Important Considerations for Inherited Assets
- No Reset of Holding Period: The holding period of the asset is considered from the time the deceased person acquired the asset. This ensures that the inherited asset is usually treated as a long-term capital asset, benefiting from the lower long-term capital gains tax rate.
- Depreciation and Previous Claims: If the inherited asset was depreciated by the previous owner (e.g., rental property), the depreciation claimed will impact the capital gains tax calculation. The inheritor must ensure proper documentation of any depreciation adjustments made.
- Fair Market Value at Inheritance: In certain cases, if the asset is inherited and sold within a short period, the FMV at the time of inheritance may be considered for calculating capital gains (for specific cases like real estate). However, in most cases, the original cost to the deceased person applies.
- Tax Exemptions and Deductions: There are certain exemptions available under the Income Tax Act for long-term capital gains on specific assets. For example, if the inheritor reinvests the proceeds in specific assets, they may be eligible for tax exemptions under sections like Section 54 or Section 54EC.
Judicial Decisions and Case Law
- CIT v. S. Ramaswamy (2012):
- In this case, the Madras High Court ruled that for an asset inherited from a deceased person, the holding period of the deceased person is applicable. The court emphasized that the inheritance does not reset the holding period, and thus, the asset qualifies for long-term capital gains tax treatment.
- CIT v. R. Srinivasan (2013):
- The Supreme Court held that for capital assets inherited from a relative, the cost of acquisition should be based on the original purchase price of the deceased. The court also ruled that capital gains tax is applicable based on the deceased’s acquisition price.
Conclusion
Under Section 49(1), when capital assets are inherited or received through bequest, the cost of acquisition is deemed to be the cost at which the previous owner acquired the asset. The holding period is considered as per the deceased person’s ownership, meaning the asset is typically treated as long-term for capital gains tax purposes.
Understanding the tax implications on inherited assets helps in accurate capital gains reporting and tax planning, especially when the inheritor later sells the asset. It is important for inheritors to be aware of the original cost of the asset, the holding period, and any potential tax exemptions available under the Income Tax Act.
Additional Resources
Learn more about Tax Provisions on the official Income Tax India website.
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