Absolute returns have to be nearly three times higher than inflation for 12.5% tax to be beneficial!

Published on / By M. Pattabiraman Twitter: @pattufreefincal

Published: July 28, 2024 at 10:00 am

Last Updated on August 6, 2024 at 11:12 pm

Budget 2024 has done away with indexation from all capital gains taxation. Two places where this will hurt the most are real estate sales and debt fund investments made before 1st April 2023. The older the investment, the more the impact.

Update:  Finance Bil 2024 has been amended. Taxpayers can now choose 12.5% without indexation or 20% with indexation, whichever is lower for LTCG on property.

We had determined earlier the return necessary from real estate sales that would benefit from 12.5% tax without indexation. This can easily be generalized with a simple thumb rule.

Let X = % capital gain (sale price – purchase price)/purchase price.

Y = % change in the cost inflation index
(CII in the year sold minus CII in the year purchased)/CII in the year purchased

If X> 2.667*Y, the 12.5% tax is favourable
If X < 2.667*Y, we will pay more tax with 12.5% than with 20% with indexation.

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Let us consider an example.

Age of Property (years)24
Price on 1st April 20012500000
Sale price20033333
Indexed purchase price9075000
Indexed Capital Gain10958333
Actual Capital Gain17533333
20% tax with indexation2279333
12.5% tax2279333
Return (cagr)9.06%
Inflation (cagr)5.52%
Abs return (ratio)7.013333
Abs change in inflation2.63
Abs return/Abs inflation change2.666667

So, for the 12.5% tax to be favourable, the abs return should be nearly three times higher than the inflation in the cost inflation index. This is a tough ask even for real estate and fairly impossible for debt funds.

Two caveats: A purchase of section 54EC bonds will change these estimates. Inflation-indexed cost of improvement on the properties can be reduced from the capital gains. This will also affect this estimate. But these are subjective and cannot be generalised.

Read more from our budget 2024 coverage