Not all properties that you inherit can be termed as ancestral property for tax purposes. Ancestral property is defined as one which a person inherits from any of three immediate male ancestors—father, grandfather and great grandfather. Properties inherited from any person apart from these three relations are not considered as ancestral properties, according to the Income-tax Act, 1961. Until 2005, only male members had rights over ancestral property, but after amendments to the Hindu Succession Act in 2005, even women enjoy equal rights over ancestral property.
Here’s how ancestral property is taxed under the Hindu Succession Act.
When a person inherits ancestral property, no tax liability arises at the time of inheritance, as India does not levy an inheritance tax at present. However, in case the inheritor decides to sell the inherited property, any capital gains earned on the sale will be taxable in his or her hands.
The capital gains taxability in respect of property depends upon the period of holding. If the property is held for an aggregate period of more than 24 months from the date of acquisition, any gains at the time of sale of such property is termed as long-term capital gains (LTCG). If the aggregate period of holding is less than 24 months, gains from the sale of such property is termed as short-term capital gains (STCG). While LTCG is taxed at the rate of 20.8% (including cess) with indexation, STCG is taxed at the slab rate applicable to the assessee.
Remember that, in case of inherited property, the aggregated period of holding is not counted from the date it was inherited by the seller, but from the date of purchase of property by the original owner who actually purchased the property.
While calculating LTCG, one needs to first determine the indexed cost of acquiring the property by taking the cost inflation index (CII) into account. Also, if there has been any major repair, improvement or addition to the property, the cost of such repairs and improvement will also need to be adjusted against inflation by applying CII.
To arrive at the indexed cost of the property, the purchase price of a property or the improvement cost has to be inflated based on the CII notified by the tax authorities. You can find the CII for various financial years on incometaxindia.gov.in. To calculate the indexed cost of acquisition of a property, multiply the purchase price of the property with the CII of the FY in which it is sold and divide the product by the CII of the FY in which it was purchased.
If the property has been acquired by the original owner prior to 1 April 2001, you have the option of taking the actual cost of acquisition or fair market value as on 1 April 2001 for calculating the indexed cost of the property.
You can claim tax exemption on the gains made from the sale of a property. The first option is to reinvest the gains in another property. If the amount of LTCG is less than ₹2 crore, you can claim tax exemption by reinvesting the gains across a maximum of two new residential properties located in India. However, if the gains amount to more than ₹2 crore, you can only reinvest in one property to claim tax exemption. The investment has to be made within the specified time frames, i.e., within one year prior to the sale date or two years from the sale date or within three years for an under-construction property.
The second option is to use the gains to construct a house within three years from the sale of property.
A third option is to invest the gains in capital gains bonds under Section 54EC of the Income-tax Act. The total investment limit in these bonds is restricted to ₹50 lakh per FY.