Selling a Property? Here’s What Counts as ‘Cost of Improvement’ to Save Capital Gains Tax

 Selling a property can trigger a significant tax liability in the form of capital gains tax. However, the Income-tax Act, 1961, allows you to reduce this tax burden by factoring in two key components: the cost of acquisition (what you paid to buy it) and the cost of improvement (what you spent to improve it).

 

In this articles we clarifies what exactly qualifies as a "cost of improvement" — a concept that often confuses taxpayers and can lead to disputes with the tax authorities.

 

What is the ‘Cost of Improvement’?

 

Simply put, the cost of improvement includes any capital expenditure you incurred to add to or enhance the value of the property. It must be a lasting improvement, not routine maintenance or repairs. This cost is crucial for calculating the capital gains on which you will be taxed.

 

The formula for calculating long-term capital gains (LTCG) on property is:
Capital Gain = Full Value of Consideration (Sale Price) - (Indexed Cost of Acquisition + Indexed Cost of Improvement)

 

What Qualifies as a Valid ‘Cost of Improvement’?

For an expense to be claimed, it must meet the following criteria:

1. Capital in Nature: The expense must add to the property's capital value. It should not be a revenue expense like annual painting or fixing a leak.
2. Incurred by the Seller: You must have spent the money yourself. You cannot claim expenses borne by a previous owner.
3. Supported by Evidence: You must have proper documentation, such as invoices, receipts, and payment proofs, to substantiate your claim.

Examples of Eligible Expenses:

• Constructing a new floor or an additional room.
• Adding a balcony, garage, or swimming pool.
• Major structural changes like strengthening foundations or walls.
• Installing permanent fixtures like modular kitchens or wooden flooring that are fixed to the property.
• Plumbing or electrical work that is part of a major renovation, not just repair.

Common Expenses That Do NOT Qualify

It is critical to know what the tax law does not consider an improvement cost.

• Routine Repairs and Maintenance: Whitewashing, repainting, broken window replacement, or routine plumbing fixes.
• Annual Upkeep: Expenses like annual service charges for a society or regular maintenance contracts.
• Loan Interest: Interest paid on a home loan cannot be added to the cost of improvement. (It is claimed separately under Section 24(b)).
• Stamp Duty and Registration Fees: These are part of the cost of acquisition, not improvement.

 

The Importance of Indexation

A key benefit for long-term assets (held for more than 24 months) is indexation. The government provides a Cost Inflation Index (CII) to adjust your purchase and improvement costs for inflation. This indexed cost is much higher than the original cost, significantly reducing your taxable capital gains.

 

Key Takeaway

Before you sell your property, meticulously compile all invoices and proof of payment for any major capital improvements you have made. Distinguishing between genuine capital improvements and mere repairs is essential for an accurate capital gains calculation and can save you a substantial amount in taxes. Always consult with a chartered accountant to ensure your claims are valid and properly documented.