Indexed cost of acquisition

A house bought for Rs 50 lakh in 2002 and sold for Rs 3.5 crore today has not really made Rs 3 crore. Much of the rise is only inflation. Taxing all of it would tax the inflation.

Indexation is the Income Tax Act's answer. It scales the old cost up to today's money before the gain is worked out.

The scaling factor comes from the Cost Inflation Index, which the Central Board of Direct Taxes notifies every year. The indexed cost of acquisition is the original cost multiplied by the index for the year of sale and divided by the index for the year of purchase.

The result is a bigger cost, so a smaller gain, so less tax.

One large change has happened. For transfers on or after 23 July 2024, indexation has gone for almost everything. Land and building bought before that date are the main exception, and even there it survives only as a comparison calculation.

The two steps. First arrive at the plain cost of acquisition. Then scale it.

Indexed cost of acquisition = Cost of acquisition x (CII of the year of transfer) / (CII of the year in which the asset was first held by the assessee, or CII of 2001-02, whichever is later)

The whichever is later clause is what stops the formula reaching back before 2001-02, and it is where marks are lost. An asset first held in 1994 uses the CII of 2001-02 as its denominator, not 1994.

The Finance Act, 2024 cut. The workbook states it in two lines:

How the surviving exception actually works. For immovable property the workbook sets out three cases:

1. Acquired and transferred before 23 July 2024 — old provisions, indexation available, LTCG at 20%.
2. Acquired before but transferred on or after 23 July 2024 — a parallel calculation. Work out the tax at 20% with indexation and at 12.50% without it, and the indexation route applies only if it gives the lower tax. The workbook adds the sting: any loss created by indexation is no longer allowed.
3. Acquired on or after 23 July 2024 — 12.5% with no indexation at all.

The same formula covers improvement. The indexed cost of improvement is computed in exactly the same manner. Cost of improvement itself only counts if incurred on or after 1 April 2001.

Where it does not apply at all. Indexation is a long-term relief. A short-term gain never gets it, and neither do the assets the Act deems short term however long they are held.

The workbook's own worked case. Mr A buys a house on 14 April 2011 for Rs 1 crore and sells it in December 2024 for Rs 3 crore. He intends to buy a new house for Rs 1.5 crore. The CII for 2011-12 is 184 and for 2024-25 is 363.

Because the property was bought before 23 July 2024 and sold after it, both columns must be computed and the lower tax applies. Indexation wins here by Rs 6,25,000 — entirely because it lifted the cost by Rs 97,28,260 and let the section 54 exemption swallow the whole remaining gain.

A second illustration from the same chapter. Mr A inherits a Mumbai house his father bought for Rs 50,00,000 in FY 2002-03, now worth about Rs 3.5 crore. Using the CII of 2020-21 (301) over the CII of 2002-03 (105):

Rs 50,00,000 x 301 / 105 = Rs 1,43,33,333

The inherited cost of Rs 50 lakh becomes Rs 1.43 crore. Note which CII went in the denominator: the year the previous owner first held it, because that is the cost the assessee inherits.

Chapter 8 (Capital Gains), section 8.4, item 4 (Indexed cost of acquisition) gives the withdrawal rule and the formula with the Rs 50,00,000 illustration; item 6 extends it to the cost of improvement; section 8.5.2 gives the three immovable-property cases and section 8.5.3 carries the Mr A worked example with the 184 and 363 index values.

Expect a straight computation using two CII figures, a question on which CII goes in the denominator (year the asset was first held, or 2001-02, whichever is later), and the post-23-July-2024 question: is indexation available, and for what.

• The denominator is the later of the year of first holding and 2001-02. For an asset held since the 1990s that means 2001-02, not the actual purchase year.
• Indexation is gone for transfers on or after 23 July 2024 except for land or building acquired before that date. Applying it to listed shares, gold or debt paper sold after that date is wrong.
• Even the surviving exception is only a comparison. For property bought before and sold after 23 July 2024, both computations are done and the one giving lower tax applies — 20% with indexation against 12.5% without.
• A loss created by indexation is no longer allowed. The parallel calculation chooses the lower tax; it does not let indexation manufacture a deductible loss.
• Indexation applies to the cost, not to the sale price. It never touches the full value of consideration.
• Short term gains never get indexation, and neither do assets deemed short term irrespective of holding period.
• Cost of improvement before 1 April 2001 is ignored entirely, so there is nothing to index for it.
• This is not the same headword as cost of acquisition. That page decides what the cost is in bonus, gift, ESOP and inheritance cases; this one scales whatever that figure turns out to be.