With the buzz going around indexation, the real estate market is preparing for its after effects. As the budget 2024 has nodded for its removal, it may impact property investments as well. Anyone who’s involved in India’s real estate sector should understand this policy change. This blog will discuss about indexation, its meaning, and benefits.
What is indexation?
Indexation is a term that adjusts your money against the rising prices or inflation. Did you know indexation has a crucial role to play in deciding gain or loss on your investments? It adjusts the purchase price against inflation. For example, you own a savings account with an interest of 5%. Suppose the cost of living increases by 3%, then your actual gain will be 2%. Here, your money’s buying potential decreases as it can buy less since the price has gone up.
And in that moment, if your account is indexed, then the interest rates will increase considering the inflation or cost of living. If the inflation increases by 4%, the bank may decide to give you an interest rate of 6%, then your actual gain will be of 2%. That’s how indexation works as a shield for your investment.
While considering indexation, you must know two other terms as well. These are — inflation and capital gains.
Inflation refers to the increase in the price of a product or service over the period. For example, something costing Rs. 100 today may cost you Rs. 115 or more next year. This continues year after year affecting your purchasing ability.
A capital gain, on the other hand, refers to the increase in the value of an investment over a given tenure. Simply put, it relates to the difference between the purchase and sale price of a specific investment. For example, suppose last year a debt fund was Rs. 20, but today, it is valued at Rs. 25, which means the investment increased. It is called capital gains.
If you own debt funds for more than 36 months, they are considered income and it comes under taxation. If it is held for less than two years, then it will be termed as short-term capital gains. Debts that are held for more than 36 months are termed as long-term capital gains.
Benefits of indexation
Indexation adjusts the purchase price of your investment to display the effect of inflation. If the price is higher, the profit margin will be low, which results in a lower tax. With indexation, you can bring down your long-term capital gains, resulting in lowered taxable income.
Because of indexation, debt funds are considered the best investment option. The rate of inflation calculated in indexation comes from the government’s CII (Cost Inflation Index).
The value in the index is determined by the central government. It is updated on the official website of the income tax.
What is the formula for calculating indexed cost?
The formula for calculating indexed cost is as follows:
(CII for the year of sale/CII for the year of purchase) x actual purchase price
What is indexation benefit for homebuyers?
Indexation offer many benefits for homebuyers as well. Let’s see how it benefits them.
Imagine, you purchased a property for Rs. 30 lakhs in 1992. The CII for that particular year stood at 199.
Imagine, you sold this property in 2010 for Rs. 99 lakhs. The CII for that particular year stood at 632.
According to the formula, you get:
(632/199) x Rs 30 lakhs = Rs. 95.27 Lakhs
This means, you will have to pay LTCG tax on the difference between Rs 95.27 lakh and Rs. 99 lakh, after implementing the indexation benefit. As per this formula, your LTCG liability will fall at Rs. 3.73 lakh.
So, that’s how indexation works and benefits investors.
