Understanding the Cost of Acquisition for Capital Gains
The calculations of the Capital Gains Tax under the Income Tax Act of India hinge upon one of the most significant activities, determining the cost of the acquisition of an asset. Acquisition cost is essentially the price paid at the time of acquiring the asset, adjusted with some allowable expenses, and forms a basic benchmark that would work into deciding the capital gain or loss at the time of sale or transfer of the asset. This article offers a full understanding of the cost of acquisition for capital gains as per the Indian Income Tax Act, the various methods of its calculation concerning different categories of assets, and the importance of the cost of acquisition for a fair determination of tax liability. File your returns on the income from capital gains.
What is the Cost of Acquisition?
The cost of acquisition under Section 55(2) of the Income Tax Act of India is looked upon as:
The amounts actually paid for the acquisition of capital assets plus incidental expenses regarding acquisition like brokerage, stamp duty, registration fees, and legal fees, etc.
For example, in purchasing a property for ₹50 lakh with ₹2 lakh paid as stamp duty and registration cost, your cost of acquisition is ₹52 lakh.
Importance of Cost of Acquisition
The cost of acquisition is the basic value to compute capital gain, which is the difference between the selling price and the cost of acquisition (adjusted for indexation if applicable). This profit will be taxed as a capital gain.
Capital Gain = Selling Price- Cost of Acquisition- Expenses on Transfer
Determining the cost of acquisition will increase the numbers you put against your taxable capital gains, and rather put them in a position to ensure correct tax compliance.
Components of Cost of Acquisition
Purchase price: Actual amounts spent to buy the asset.
Incidental Expenses: The costs incurred directly towards acquiring the assets, for instance, brokerage, stamp duty, registration charges, and legal fees.
Improvement cost: These are the costs incurred in attaching value to an asset either through modification or addition after purchase (Section 55(1)(b)).
Cost in Case of Inherited or Gifted Assets:
If an asset has been inherited or received as a gift, its cost of acquisition shall generally be the cost at which the previous owner acquired that asset.
Where such previous owner acquired the asset prior to April 1, 2001 – for long term capital assets, then the fair market value as at April 1, 2001 shall be taken as the cost of acquisition (Section 55(2)(b)).
How to Calculate Cost of Acquisition in Different Scenarios
1. For Purchased Assets
The purchase price, along with incidental expenses directly related to considering the acquisition, would be adjusted.
The cost of any improvements would then also be added.
For example, you purchase a flat for ₹30 lakh, pay ₹1 lakh as brokerage, and spend ₹2 lakh on renovations.
Cost of acquisition = ₹30 lakh + ₹1 lakh + ₹2 lakh = ₹33 lakh.
2. For Inherited or Gifted Assets
The cost of acquisition will be the cost at which the previous owner purchased the asset.
If the previous owner acquired the asset before April 1, 2001, fair market value on April 1, 2001, will be considered the cost.
Example: Your father bought a plot for ₹10 lakh in 1990. If you inherit it, the cost of acquisition for capital gains calculation will be the FMV of the plot as of April 1, 2001 (according to government valuation or registered value).
3. For Assets Acquired Before April 1, 2001
The Indian Income Tax Act uses April 1, 2001, as the ‘cost inflation index (CII) base year’.
For the assets acquired before this date, you could either take the actual cost or FMV as of April 1, 2001, whichever is more beneficial to you.
Indexation and Its Effect on the Cost of Acquisition
Indexation allows you to adjust the cost of acquisition to account for inflation, thereby reducing your taxable capital gains.
CII is issued by the government every financial year.
The indexed cost of acquisition will be calculated as follows:
Indexed Cost = Original Cost x CII of Year of Sale/CII of Year of Purchase.
This adjustment helps in representing the true cost in current-day terms, especially for long-term capital assets held for more than 24 months (real estate) or 12 months (equity shares, mutual funds).
Example:
Purchasing a property in 2010-11 for ₹10 lakh (CII = 167) and selling in 2023-24 (CII = 348)
Indexed Cost = ₹10,00,000 × 348 / 167 = ₹20,83,233
Hence, this indexed cost will be adopted to compute capital gains rather than the original ₹10 lakh.
Special Considerations of Cost of Acquisition
Capital Gains on Shares: Brokerage and transaction fees are included in the cost of acquisition.
Gifted Property: If you have received the property as a gift, the cost would be based on the donor’s purchase cost.
Capital Gains on Agricultural Land: Agricultural land situated in rural areas is generally exempt from capital gains tax.
Practical Issues Attached With Determining the Cost of Acquisition
Lack of Proper Documentation: Many taxpayers do not have purchase records, assets being of little concern to them.
Valuation of Inherited Assets: Estimating FMV as of April 1, 2001, could be difficult without government valuation information.
Understanding Complex Rules: The laws about the cost of acquisition may vary and would require professional guidance.
Get Started with TaxDunia
The cost of acquisition is an important factor in the calculation of capital gains tax under Indian Income Tax legislation. It indicates taxable gain or loss when you transfer capital assets such as property, shares, or mutual funds. In working with the purchase price, incidental expenses add improvements and indexation benefits where applicable, and you would have computed your cost of acquisition accurately and reduced your tax. Let the professionals help you file the taxes, and get customized business advice from seasoned experts.
