LTCG on immovable properties: How non-indexed gains can push up your total income, trigger surcharge

The confusion stems from the practical application of Section 112(1)(a), inserted through the Finance (No 2) Act, 2024. In essence, this section governs how LTCG on assets such as land and buildings is computed and taxed. For all transfers of land or building on or after July 23, 2024 (where the asset was acquired before that date), LTCG is now computed in two ways:

-          20 percent with indexation; and

-          12.5 percent without indexation,

with the proviso that the lower of the two tax liabilities is taken as the final liability.

Here’s an example:

·         Sale consideration: Rs 1,55,08,000

·         Purchase cost: Rs 98,86,000

·         Date of purchase: September 25, 2013

·         Date of sale: September 2, 2024

·         Cost Inflation Index (CII) for 2013-14: 220

·         CII for 2024-25: 363

As per the proviso to Section 112(1)(a), the lower tax is chosen. In this case: tax payable = Rs 0.

This can be explained better as in the chart below:

Also read: How new tax rules are chipping away at real estate's investment appeal

Non-indexed LTCG pushes up gross total income

While Section 112(1)(a) addresses the tax rate mechanism, the bigger debate post July 23, 2024, is: Why is the entire LTCG—computed without indexation—being added to gross total income (GTI)?

Professionals filing returns using the ITR utility are noticing that:

·         The full non-indexed gain is being added to GTI

·         Tax is computed at 20 percent or 12.5 percent, whichever is lower

·         But the inflated GTI impacts surcharge, rebate under section 87A and deduction eligibility

This has led to speculation that the ITR utility is defective. However, the real question is: is the utility wrong, or is it simply implementing the law as amended, albeit confusingly presented?

To answer this, we need to dig into the legal mechanics of capital gain computation and taxation, governed primarily by Section 48 and Section 112(1)(a), respectively

Understanding the legal rationale

To resolve the debate, it is critical to distinguish:

-          Section 48, which governs computation of capital gains.

-          Section 112(1)(a), which governs the tax rate applicable to those gains.

Section 48 determines the quantum of capital gain, while Section 112 decides how that gain is taxed, but many professionals conflate these two steps.

The second proviso introduced via Finance (No 2) Act, 2024, states that indexation benefit applies only to transfers before July 23, 2024. "Provided further that where long-term capital gain arises from the transfer (which takes place before the 23rd day of July, 2024) of a long-term capital asset... the provisions of clause (ii) shall have effect as if for the words 'cost of acquisition' and 'cost of any improvement', the words 'indexed cost of acquisition' and 'indexed cost of any improvement' had respectively been substituted..." it says.

So, for all transfers executed on or after July 23, 2024, the LTCG is computed using non-indexed cost of acquisition and non-indexed cost of improvement.

Implication #1: The LTCG computation under Section 48 is to be done without indexation for post-July 23 sales. Implication #2: That non-indexed gain becomes the amount to be added to the GTI.

Nowhere in the law does it say that only the taxable portion should be added to GTI. The capital gain, as per the computation mechanism, enters into total income first, and taxes are calculated thereafter. Nothing in the law allows only the taxable portion to be added to GTI. Income is first computed (Section 48), then tax is levied (Section 112).

Why non-indexed LTCG is added to gross total income

"Why should my GTI increase if tax is being charged at a concessional rate?" taxpayers argue.

The answer lies in the computation sequence:

1.      Compute LTCG (without indexation, post July 23).

2.      Add it fully to GTI

3.      Apply tax under Section 112(1)(a) on the LTCG net of Section 54 relief, but the GTI remains inclusive of full gain.

Hence, utility showing the entire non-indexed gain in GTI is actually as per law even if it looks unusual to those accustomed to earlier indexation-based methods.

The indexation-taxation disconnect

And here's where confusion arises: before July 23, 2024, LTCG on sale of property was computed with indexation, leading to a lower gain, which was then included in GTI.

After July 23, 2024, LTCG is computed without indexation, which inflates the GTI. Taxpayers wrongly assume that indexation benefit affects only tax but in reality, it affects the very amount of income computed and entered into the GTI.

Let us not forget that GTI is a function of income heads, not tax slabs. The LTCG is an income under the head ‘Capital Gains’, and must be added in full to GTI as computed under Section 48. Tax is applied separately under special rate regimes like Section 112, but that does not change the income figure.

The impact on taxpayers

This legal position, though technically sound, has serious implications:

1. GTI is inflated, even if tax payable is relatively low due to Section 112(1)(a) alternative options.

2. Surcharge thresholds may be triggered (e.g., Rs 50 lakh, Rs 1 crore) merely due to inflated GTI.

In conclusion, the widespread criticism that the post July 23 ITR utility is wrong or "not reflecting indexation correctly" is largely misplaced because the utility is simply following the amended law. The real change lies in the removal of indexation benefit through the second proviso to Section 48, applicable from July 23, 2024, onwards.

The ITR utility, in adding the full non-indexed gain to GTI, is only mirroring the statute, even if the presentation lacks clarity. Understanding the difference between computation (Section 48) and taxation (Section 112) is essential.

While Section 112 softens the tax blow with concessional rates, Section 48 controls what gets added to your total income and that, post23 July, is unfortunately the full unindexed gain.

Section 54 exemptions—the relief, and the catch

Exemptions under sections 54, 54EC, 54F, etc, are critical planning tools for LTCG mitigation. They allow capital gains to be reinvested in notified assets, thus exempting the amount so reinvested from tax.

In the example above:

·         LTCG without indexation: Rs 56,22,000

·         Investment in 54EC bonds: Rs 50,00,000

·         Exemption claimed: Rs 50,00,000

·         Tax payable: Rs 0 (lower of the two liabilities under Section 112(1)(a)

However, the full Rs 56.22 lakh still inflates GTI, impacting surcharge calculations, even though no tax is finally payable.

Please note again that despite the exemption fully absorbing the gain for tax purposes, Rs 6.22 lakh is still added to GTI, resulting in surcharge and other consequences.

While Section 112(1)(a) provides a beneficial method for tax computation by allowing the lower of two tax options, there is no parallel provision modifying the computation of GTI.

As a result, there is a conceptual disconnect: tax is levied on a minimised base (after indexation and exemption) and surcharge is computed on a maximised base (gross LTCG without indexation). This leads to an asymmetric outcome, where the effective tax burden rises not due to the rate but due to the base shifting mechanism.

For many middle- and upper-middle-class taxpayers, a one-time sale of property can inflate their GTI and push them into higher surcharge brackets, despite having no actual capital gain (after inflation adjustment), reinvesting the entire proceeds in 54EC bonds or being otherwise eligible for reduced liability. This distorts the spirit of concessional taxation and penalises genuine reinvestment.

The final word

The dual-path approach to taxing LTCG under Section 112(1)(a), when read with Section 48, creates a silent but significant distortion in overall tax liability. While tax is calculated on the lower of two bases, income is inflated on a notional and non-indexed gain. For taxpayers, this results in an illusory benefit: a lower tax rate that quietly triggers a higher surcharge, affecting their final outgo. In taxation, the burden is often not in the rate but in the base.

It is imperative for both practitioners and taxpayers to be aware of these nuances and to take informed decisions during filing. A regime that promises simplification must not penalise economic substance under the guise of procedural form.

(The author is a practising chartered accountant and partner, SBHS & Associates)

Disclaimer: The views expressed by experts on Moneycontrol are their own and not those of the website or its management. Moneycontrol advises users to check with a financial advisor before taking any decisions.