Explainer: Will changes to LTCG tax affect long-term investments in the real estate sector?

People buying new properties will not have the indexation shield, and may expect an impact in tier II cities where taxes play an important role to investors.

While Finance Minister Nirmala Sitharaman had announced sweeping changes to the capital gains regime in her budget speech on July 23 removing indexation benefit and lowering the long-term capital gains tax (LTCGT), the government had to amend these changes after widespread criticism of the move, especially for its impact on real estate investments. On August 7, Sitharaman said that the government's decision to remove indexation benefits from real estate and lower the LTCG tax from 20 percent to 12.5 percent was not due to revenue considerations but to simplify all asset classes, including real estate.

Following the amendments, which allow an investor to choose between the two tax regimes—12.5 percent with no indexation or 20 percent with indexation benefit—for properties bought before July 23, experts say that if a property's value has significantly outpaced inflation, the 12.5 percent rate might be more beneficial.

Indexation could be advantageous in cases where property appreciation is closer to the inflation rate. The new amendments may boost short-term investments in the real estate sector, including a significant fallout in long-term investments, experts add.

Rs 1-2 crore segment to see an uptick in demand

Ritesh Mehta, senior director of residential services and developer initiatives, JLL India, said, "Real estate has always been a long-term asset class where investors used to hold the properties for over 10-15 years. However, now we may see a new set of investors emerging to compete with equity, not from a returns perspective but from a liquidity perspective. We may see more churning in real estate assets within five years of investment."

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Experts added that the new amendment will boost investments in the Rs 1-2 crore housing segment where the appreciation rate is the highest and provides quicker returns. This may also translate into a minor dent in long-term investments, which will no longer have the indexation shield against inflation for properties bought after July 2024.

"To an extent, the impact can be disadvantageous for new consumers. Real estate is known for stability—moderate price growth and diversification of investments among all asset classes. People buying new properties will not have the indexation shield, and we may expect an impact in tier II cities where taxes play an important role to investors," said Vivek Rathi, who heads research at Knight Frank India.

Rathi added that the amendment could also lead to marginally lower capital returns of about 1-5 percent for new properties bought after July.

Affordable housing segment to remain unaffected

Overall, the recent amendments will lead to end users being long-term investors with higher ticket sizes, Mehta explained. For the luxury segment (properties above Rs 5 crore), about 95 percent will remain as end users and the rest will be investors. And for mid-segment properties (Rs 1-2 crore), about 75 percent will be end-users and 25 percent will be investors, he added. This will have no impact on the affordable housing segment, as almost all buyers will continue to remain end users, so in the absence of a sale, the question of capital gains does not arise.

Experts added that for properties bought after July 2024, there will be a spurt in short-term investment for mid-segment properties where investors are likely to exit within five years.

"Over the last two decades—when the Indian economy was evolving—tax incentives were acting as drivers to boost investments across multiple asset classes. However, today we have moved to a phase where we might not need further incentives to drive investments in sectors like real estate. Tax outflow is one of the several factors that people will look at while investing in real estate and will not solely depend on for decision making," said Vimal Nadar, head of research at Colliers India.