Indexed Cost of Acquisition [Explanation (iii) to Section 48]

Explanation (iii) to Section 48 of the Income Tax Act, 1961, defines the indexed cost of acquisition for computing long-term capital gains (LTCG). This provision adjusts the original purchase price of an asset for inflation using the Cost Inflation Index (CII), ensuring taxpayers are taxed only on real gains (after accounting for inflation).

Key Provisions

1. Formula for Indexed Cost of Acquisition

• CII: Published annually by the Central Government (e.g., CII for 2025-26 = 376).
• Base Year: 2001-02 (CII = 100). For assets acquired before 1st April 2001, taxpayers can use higher of actual cost or FMV as of 1st April 2001.

2. Applicability

• Long-term assets only(held >24 months for immovable property, >12 months for shares).
• Exclusions:
  • Depreciable assets(Section 50): Always treated as short-term.
  • Bonds/Debentures(except sovereign gold bonds).

3. Special Cases

(a) Inherited/Gifted Assets

• Cost of acquisition= Previous owner’s cost.
• Indexation starts from the year the previous owner first held the asset(not the year of gift/inheritance).
  • Example: If a property was bought by a parent in 1995 (CII = 100) and gifted in 2020, indexation uses 1995-96as the base year.

(b) Assets Acquired in Instalments

• Two views exist:
  1. School 1: Use CII of the allotment year(e.g., 2018 for a property booked in 2018, even if payments spanned 2018–2023).
  2. School 2: Apply indexation separately for each instalment(e.g., 2018 payment indexed with 2018 CII, 2019 payment with 2019 CII).
• Preferred approach:

School 2 (pro-rata indexation) aligns with the principle of matching inflation to actual cash outflow.

(c) Property Under Construction

• Holding periodbegins from the date of allotment/agreement (not possession).
• Example: If a flat was booked in 2015 (CII = 254) and possession received in 2020, indexation uses 2015-16as the base year.

Recent Changes (2024 Budget)

• Indexation benefit discontinuedfor most assets (effective 23rd July 2024).
  • Exception: For land/buildings acquired before 23rd July 2024, taxpayers can choose:
    • 5% tax without indexation, or
    • 20% tax with indexation.

Practical Examples

1. Asset Purchased in 2005 (CII = 117), Sold in 2025 (CII = 376):
2. Inherited Property (Previous Owner Bought in 1990, FMV in 2001 = ₹12 lakh):
   • Cost: Higher of actual cost or ₹12 lakh (2001 FMV).
   • Indexation: Uses CII of 2001-02 (100)