Removal of indexation benefit raises tax burden, may dampen investor sentiment

Despite the concerns regarding removal of the indexation benefit, shares of realty companies staged a sharp rebound on July 24, surging upto 8 percent.

The Budget 2024 announced a significant change for the real estate sector by removing the indexation benefit on the sale of property, reducing the Long Term Capital Gains (LTCG) tax rate from 20 percent to 12.5 percent, but applying it without the indexation benefit.

Experts believe this will increase the overall tax burden for property sellers and dampen investor sentiment. However, they also see potential growth in affordable and mid-level housing segments due to government initiatives aimed at revitalizing MSMEs and infrastructure development.

What is indexation benefit?

Indexation is used to adjust the purchase price of an investment to reflect the effect of inflation on it.

The government has clarified that the indexation benefit for properties bought after 2001 will be removed while retaining it for properties bought before 2001.

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Tax burden or tax saving?

Former president of CREDAI Jaxay Shah said the impact of the proposed changes would be neutral if the average property return is 12 percent over more than four years, with inflation at 5 percent.

However, if the return exceeds 12 percent with 5 percent inflation, there could be a tax saving under the new amendment compared to the current rate, Shah added.

Nitin Bavisi, CFO, Ajmera Realty & Infra India explained in a conversation with Moneycontrol that for the sale of a property acquired after 2001 in 2024 or thereafter, the capital gains tax will be 12.5 percent instead of 20 percent earlier. Meanwhile, the long-term capital gains tax on equities has been hiked to 12.5 percent from 10 percent.

"So, if one considers moving the capital out from long-term capital gains from shares and securities, they are moving out with a higher tax effect of 25 percent. However, with real estate they are moving out with a 37.5 percent reduced tax effect," he said.

Impact on demand, supply

Developers heavily reliant on investors will be adversely affected. However, the elimination of the indexation benefit when applying LTCG means the overall tax outflow will be higher under this new regime. This move is likely to dampen investor sentiment, removing key incentives and directly impacting developers dependent on investors, said Sachin Bhandari, Executive Director and CEO, VTP Realty.

Shishir Baijal, Chairman and Managing Director, Knight Frank India believes that if the property's value has increased more than the inflation rate, the new 12.5 percent tax rate is expected to be more advantageous for real estate sellers compared to the previous 20 percent tax rate after adjusting for indexation.

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The removal of indexation benefits could potentially lower demand from investors since indexation adjusts the purchase price for inflation, thereby reducing capital gains tax on property sales.

Sans this benefit, the tax liability increases, and this will reduce the attractiveness of real estate as an investment when viewed against other asset classes, said Prashant Thakur, Regional Director & Head – Research, ANAROCK Group.

According to Jain, high-value properties will be most impacted, and we may see a reduction in demand for them. Primary home buyers might not be affected as much since their main motive for buying homes is to use them for residence, not for investment returns. However, overall market sentiment could influence even end-user decisions, he said.

Price corrections in real estate?

Real estate developers may respond by offering incentives and focusing on affordable housing to attract buyers in the primary sales market. "It may reduce speculative demand and increase supply, leading to some price corrections. In the short term, this could result in a notable price decline as sellers compete for fewer buyers," Thakur said.

However, over time, the market will regain stability and prices will reflect genuine end-user demand rather than demand by speculative investors. Developers may shift their crosshairs to affordable and mid-segment housing, he added.

Mitesh Jain, Partner at Economic Laws Practice, noted the overall increase in capital gains taxes across various investments. He pointed out that while the LTCG rate on property has been reduced, the removal of indexation will likely result in higher taxes, particularly affecting lower and middle-income taxpayers.

Meanwhile, Dhruv Agarwala, Group CEO of Housing.com and PropTiger.com, sees the removal of the indexation benefit as a major shift that could increase the tax burden on real estate transactions. Despite the reduction in the LTCG tax rate, he believes the changes could lead to higher taxes for property sellers.

Overall, Budget 2024's strategic investments and reforms are expected to drive substantial growth in the real estate sector, benefiting both developers and homebuyers alike.”

Impact on realty stocks

Despite the concerns regarding the removal of the indexation benefit, shares of realty companies staged a sharp rebound on July 24, surging up to 8 percent.

Shares of Macrotech Developers were up 3 percent, Sobha up 3.4 percent, Prestige Estates up 6.7 percent, Ajmera Realty up 3.21 percent and Oberoi Realty gained 3 percent.