Capital gains on property received by way of gift or inheritance (will) are calculated by taking the cost of acquisition of the previous owner, as provided under Section 49(1) of the Income Tax Act. Additionally, the holding period of the previous owner is also considered to determine whether the gains are short-term or long-term.

As per Section 55(2), if the property was originally acquired before 1 April 2001, the taxpayer has the option to substitute the fair market value (FMV) as on that date as the cost of acquisition for computing capital gains.

To account for inflation, taxpayers can apply the concept of indexed cost of acquisition, which helps reduce the taxable capital gains amount. In inheritance cases, the Income Tax Department has traditionally restricted indexation benefits only from the date of inheritance, which often results in a higher tax liability.

However, several High Court judgments have provided relief to taxpayers. Landmark rulings such as CIT v. Manjula J. Shah (Bombay High Court) and Arun Shungloo Trust v. CIT (Delhi High Court) have upheld that indexation should be allowed from the date the previous owner originally acquired the property, and not from the date of inheritance or gift.

For instance, if a plot inherited by a taxpayer is sold in 2023, courts have permitted the computation of capital gains by applying indexation from 1 April 2001, substantially lowering the tax burden.

Under the Income Tax Act, “Capital Gains” is the fourth head of Gross Total Income, covering any profits or gains arising from the transfer of a capital asset during the relevant financial year.

Section 49(1) of the Income Tax Act provides that when a capital asset becomes the property of an assessee through any of the specified modes—such as gift, will, inheritance, or partition of a Hindu Undivided Family (HUF)—the cost of acquisition of that asset shall be deemed to be the cost at which the previous owner acquired it. This cost can be increased by the cost of any improvements made to the asset, whether incurred by the previous owner or by the assessee, as applicable.

Accordingly, when a property received by way of gift, will, or HUF partition is subsequently sold, the cost of acquisition for computing capital gains is taken as the cost incurred by the previous owner, not the value at which the assessee received the property. In addition to this, the period of holding of the previous owner is also included while determining whether the capital gains are short-term or long-term.

Section 55(2) of the Act explains that the meaning of “cost of acquisition” varies for different types of capital assets, such as goodwill, shares, securities, equity shares of a company, units of an equity-oriented mutual fund, or units of a business trust.

In the case of other capital assets, where the asset became the property of the assessee before 1 April 2001, the assessee has the option to adopt either:

• the actual cost of acquisition, or
• the fair market value (FMV) of the asset as on 1 April 2001,
  whichever is more beneficial.

Further, where the capital asset becomes the property of the assessee through any of the modes specified under Section 49(1), the same provisions regarding the cost of acquisition apply.

Section 49 also clarifies that in cases involving the conversion of a proprietary concern or partnership firm into a company, the cost of acquisition for capital gains purposes shall be the cost at which the proprietary concern or partnership firm originally acquired the asset.

With respect to the cost of acquisition and the period of holding of assets received by way of gift, will, or inheritance, there has been a difference of opinion. However, the Income Tax Department has taken a distinct view regarding the indexed cost of acquisition.

According to the Department, the year in which the asset is received by the assessee should be considered for valuation purposes, and the market value prevailing in that year should be taken as the cost. Based on this interpretation, the Department contends that indexation benefit is not applicable, as the asset was not purchased by the assessee and therefore no inflation-adjusted cost is required to be computed.

As per Section 2(42A) of the Income Tax Act, the period of holding of the previous owner is to be considered for determining whether a capital asset is short-term or long-term. Further, Section 49(1) provides that where a capital asset is acquired by way of gift, will, or inheritance, the cost of acquisition shall be deemed to be the cost incurred by the previous owner.

Illustration

Mr. Atulbhai received a plot of land in 2022 under the will of his grandfather. The grandfather had purchased the plot in 1981 for ₹10 lakh. The fair market value (FMV) of the plot as on 1 April 2001 was ₹40 lakh.

In 2023, Atulbhai proposes to sell the plot for ₹1 crore.

Department’s View

According to the Income Tax Department’s interpretation:

• Since the plot was originally acquired in 1981 and sold in 2023, the asset qualifies as a long-term capital asset.
• The cost of acquisition is taken as ₹10 lakh, being the actual purchase cost incurred by the grandfather in 1981.
• As the assessee did not purchase the asset himself, the Department holds that indexation benefit is not available.
• Accordingly, capital gains would be computed by deducting ₹10 lakh from the sale consideration of ₹1 crore, without allowing indexation.

Disclaimer: The content on this website is for informational purposes only and does not constitute legal, financial, or professional advice. Please consult qualified experts before acting on any information. K M GATECHA & CO LLP accepts no liability for errors, omissions, or outcomes from the use of this content. This site is not an advertisement or solicitation.