Cost of improvement
Also written Indexed cost of improvement
Capital expenditure incurred on or after 1 April 2001 on additions or alterations to a capital asset, by the owner or a previous owner, deducted along with cost of acquisition in computing capital gains.
In plain language
When a house is sold for more than it cost, not all of the difference is gain. If the owner added a floor or rebuilt the kitchen, that money went into the asset too.
Cost of improvement is the workbook's term for that spending: all expenditure of a capital nature incurred on or after 01-04-2001 in making any addition or alterations to the capital asset, either by the assessee or by the previous owner. It is deducted, alongside the cost of acquisition and transfer expenses, from the full value of consideration in computing both short-term and long-term capital gains.
The word "capital" matters. It covers additions and alterations, not expenses that are already allowed as deductions under another head of income.
How it works
Where it sits in the computation (identical in structure for short-term and long-term gains):
| Full value of consideration | xxx |
| Less: expenditure wholly and exclusively in connection with transfer | (xxx) |
| Less: cost of acquisition | (xxx) |
| Less: cost of improvement | (xxx) |
| Capital gain or loss | xxx |
The rules:
- Capital expenditure on or after 01-04-2001 counts, whether incurred by the assessee or the previous owner.
- If the asset was acquired before 01-04-2001, any improvement cost incurred before 01-04-2001 is ignored.
- For goodwill of a business, or a right to manufacture, produce or process any article, or a right to carry on any business or profession, cost of improvement is nil.
- For Market Linked Debentures and Specified Mutual Funds, cost of improvement is not allowed, whoever incurred it.
- It excludes any expenditure deductible in computing income under house property, business or profession, or other sources.
Indexation. Indexed cost of improvement is computed the same way as indexed cost of acquisition. After the Finance Act, 2024, for transfers on or after 23 July 2024 indexation is not available except as a parallel calculation for land or building acquired before that date.
A worked example
Illustrative figures.
Mrs Bhatia bought a house in June 2016 for Rs 60,00,000. In 2019 she added a floor for Rs 15,00,000, and in 2021 she rebuilt the kitchen for Rs 3,00,000. Throughout, she claimed interest on her home loan as a deduction under house property. She sells in August 2025 for Rs 1,20,00,000, paying brokerage of Rs 1,00,000.
Held for more than 24 months, the house is a long-term capital asset.
Full value of consideration 1,20,00,000
Less: brokerage (transfer expense) (1,00,000)
Less: cost of acquisition (60,00,000)
Less: cost of improvement (18,00,000) ← 15,00,000 + 3,00,000
Long-term capital gain 41,00,000
Tax at 12.5% (before surcharge, cess) 5,12,500
The home loan interest she deducted under house property cannot be added to cost of improvement as well — it was already deductible under another head. Because the house was acquired before 23 July 2024, the workbook notes a parallel calculation with indexation is also available for land and building; that comparison needs the notified Cost Inflation Index figures for each year.
The inherited-house variant. Suppose instead she inherited a house her father bought in 1995. He added a room in 1998 and a terrace in 2006. The 1998 cost is ignored (before 01-04-2001, on an asset acquired before that date). The 2006 cost counts, even though her father, the previous owner, paid for it.
Why NISM asks about it
Chapter 8 (Capital Gains), section 8.5 — Computation of Capital Gains from Transfers — item 5 (cost of improvement) and item 6 (indexed cost of improvement), after cost of acquisition in Table 8.4. Expect a computation that lists transfer expenses, cost of acquisition and improvements with dates, and asks which amounts to deduct.
Common exam traps
- Only capital expenditure on or after 01-04-2001 counts. Pre-2001 improvements on a pre-2001 asset are ignored.
- The previous owner's improvements count — relevant for inherited or gifted assets.
- Nil for goodwill and for rights to manufacture or carry on business.
- Not allowed at all for MLDs and Specified Mutual Funds.
- No double deduction. Anything deductible under house property, business or other sources is excluded.
- Transfer expenses such as brokerage are a separate line, not cost of improvement.
Check yourself
1.In the indexed cost of acquisition formula, what is used as the denominator?
- a)The CII of the year in which the asset is transferred
- b)The CII of the year in which the asset is first held by the assessee, or the CII of 2001-02, whichever is later
- c)The CII of 2001-02 in every case
- d)The CII of the year in which the assessee filed his first return
Show the answer
Answer: (b) The CII of the year in which the asset is first held by the assessee, or the CII of 2001-02, whichever is later
The formula is Cost of Acquisition × CII of the year in which the asset is transferred ÷ CII of the year in which the asset is first held by the assessee OR CII of 2001-02, WHICHEVER IS LATER. The "whichever is later" matters because 2001-02 is the base year — for an asset first held in 1985 you cannot go behind 2001-02. For the indexed cost of improvement, the denominator is the CII of the year the improvement was made.
Where this is taught
Free preparation for NISM Series X-BRelated terms
- Cost Inflation IndexAn index notified by the CBDT each year, with 2001-02 as the base of 100, used to restate the cost of a long-term capital asset in current rupees so that inflation is not taxed as capital gain.
- Cost of acquisitionWhat an assessee is treated as having paid for a capital asset — usually the price actually paid, but overridden by special rules for bonus shares, ESOPs, gifts and inherited assets.
- Indexed cost of acquisitionCost of acquisition scaled up by the Cost Inflation Index, so that only the real gain is taxed; withdrawn for transfers on or after 23 July 2024 except for land or building acquired before that date.
- Long-term capital assetA capital asset held for more than the prescribed period before transfer — generally more than 24 months, and more than 12 months for listed securities and equity oriented fund units.
- Specified Mutual FundA mutual fund caught by section 50AA — gains on it are short-term no matter how long it was held, and are taxed at the investor's slab rate.
- Allotment dateThe date shares are actually credited to an employee under an ESOP — distinct from the vesting date and the exercise date, and the date from which the period of holding for capital gains is counted.
- Expenditure in connection with transferCosts incurred wholly and exclusively to complete a transfer — brokerage, stamp duty, registration and legal fees — deductible from capital gains, but STT and CTT are specifically barred.