Indexed Cost of Improvement [Explanation (iv) to Section 48]

Explanation (iv) to Section 48 of the Income Tax Act, 1961, governs the indexation of improvement costs for computing long-term capital gains (LTCG). This provision allows taxpayers to adjust capital expenditures made on improving an asset for inflation, ensuring only real gains (after accounting for inflation) are taxed.

Key Provisions

1.  Formula for Indexed Cost of Improvement

• CII (Cost Inflation Index): Published annually by the Income Tax Department (e.g., CII for 2024-25 = 348).
• Improvements made before 1st April 2001 are ignored(Section 55(1)(b)).

2.  Applicability

• Only for long-term capital assets(held >24 months for immovable property, >12 months for shares).
• Exclusions:
  • Depreciable assets(Section 50) → No indexation (always short-term gains).
  • Self-generated assets(e.g., goodwill, trademarks) → Improvement cost = Nil.

3.  Conditions for Claiming Improvement Cost

• Must be a capital expenditure(not repairs/maintenance).
• Must enhance the asset’s value(e.g., structural changes, legal title improvements).
• Must be supported by bills/contracts(no oral claims allowed).

Practical Examples

Case 1: Property Improvements

• Asset purchased in 2010 (CII: 167)→ Cost = ₹20 lakh.
• Improvement in 2015 (CII: 254)→ ₹5 lakh (new flooring).
• Sold in 2025 (CII: 348)→ Indexed improvement cost:
• Total indexed cost= ₹20 lakh (indexed) + ₹6.85 lakh = ₹26.85 lakh.

Case 2: Inherited Property with Improvements

• Previous owner’s cost (2005, CII: 117)→ ₹10 lakh.
• Heir’s improvement (2020, CII: 301)→ ₹3 lakh (new roof).
• Sold in 2025 (CII: 348)→ Indexed improvement cost:
• Total cost= ₹10 lakh (indexed from 2005) + ₹3.47 lakh.

Comparison: Indexed Cost of Acquisition vs. Improvement

Recent Changes (2024 Budget Impact)

• Indexation discontinuedfor most assets (effective 23rd July 2024).
• Exception: Real estate acquired before 23rd July 2024can choose:
  • 5% flat tax (no indexation), or
  • 20% tax with indexation.