A zillion views follow every time the Government presents its annual Budget — some nuanced, some analysed in depth and some triggered by emotions. The proposed change in capital gains tax on real estate saw all of it. While the tax department put out illustrations showing why it will be beneficial to most taxpayers, others who weren’t convinced put in equal effort to disprove with numbers, the government’s stand.

Are you confused as to who is right? Give everything that you see and hear a pass. The problem with the examples that have been shared is that, in most cases, only specific instances are shown. But each of our situations may be unique. Different people would have bought properties at different points in time and had different levels of appreciation on their property. Some would have held property only for years, some for decades and some would have inherited properties bought one or two generations before. The only thing common is the rate of inflation or indexation.

Do the math yourself

So, to keep it simple,  do the math yourself, using two simple variables X and Y.  

Let X here represent the capital gains post indexation. The tax on capital gains post indexation was 20 per cent.

Let Y represent the capital gains without indexation. The Government has now proposed capital gains tax on this at 12.5 per cent.

Whether this new tax is good for a taxpayer can be confirmed from a simple equation, which is:

 When 12.5Y < 20X, ie if 12.5 per cent upon Y is lesser than 20 per cent upon X, then this new tax proposal is beneficial to you. You will now pay less tax in these instances.

The above equation can be further simplified to Y/X <20/12.5 or Y/X < 160 per cent

What does this mean in simple English? As long as capital gains without indexation is lesser than 160 per cent of capital gains with indexation, you will pay less taxes now. It is the same property sold at the same price. So only difference between X and Y depends on the level of inflation.

Note the three important factors here - one, the lower the X, the higher the chances that Y/X will tend to increase above 160 per cent; two, the higher the inflation relative to growth in property prices, the lower X will be; three, if X is negative, ie if cumulative inflation is higher than capital gains, then this equation does not apply.

The two tables explain how this works. Table 1 gives an illustration of how Y/X will trend when annualised inflation is 5 per cent and annualised growth in property prices is 10 per cent. Inflation assumed here at 5 per cent is the upper end of the 4-5 per cent generic range of indexation for inflation as pointed out by the Income Tax Department. This is also one per cent above the RBI’s inflation target of 4 per cent.

Table 2 gives an illustration of how Y/X will trend under different scenarios. In any scenario, the year in which Y/X drops below 160 per cent, is the year from which the new tax proposal will work out better for you.  

Table 1
Table 2
Two simple takeaways

1)     Greater the property price appreciation over inflation, lower will be your taxes now. So if you had purchased prior to the start of the property boom in 2003-04, the new proposal can work to your advantage. So will it, if you are inheriting ancestral property.

2)     The longer your holding period, the more beneficial is the new proposal. As long as property price CAGR is above inflation CAGR, Y/X will tend to below 160 per cent. Of course, if the difference is very small, then it will take a very very long time. In which case, the point to ponder is why should anyone buy property as an investment if its outperformance over inflation is going to be very marginal?

In general, property, being a real asset with limited supply, tends to outperform inflation by a good margin in the long run. This makes the new real estate capital gains tax proposal a good deal for long-term investors. If you are such an investor and not a speculator, you can welcome this new proposal.

3)    In cases where the property price CAGR has underperformed inflation or outperformance is only marginal, and the new tax proposal is unfavourable, then the genesis for that problem lies either in a poor or unlucky investment decision.

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