Before we get started lets understand....
Income Tax laws have a provision of reducing the effective tax burden on long term capital gains that you earn.
For example : The cost inflation index (CII) is calculated as shown:
This index is then multiplied by the purchase price of the asset to arrive at the inflated price representing the true value of the asset at the time of tax computation.
In case of long-term capital gains, the tax liability is computed using two methods
The tax liability will be the lower of the two.
So, indexed cost of acquisition would be:
i.e. 4,50,000 - Rs. 3,93,443 = Rs. 56,557
Therefore tax payable will be 20% of Rs. 56,557 which comes to Rs. 11,311 Had it not been for indexation:
Capital Gains tax would have been as follows:
i.e. 4,50,000 - Rs. 2,50,000 = Rs. 2,00,000
Therefore, tax payable @ 10% of Rs. 2,00,000 would have come to Rs. 20,000.
So you benefit by saving Rs. 8,689 in taxes by using indexation!!
***The above is only for illustration purposes only.
What – Indexation means adjusting the cost of capital asset by incorporating the impact of inflation during the period of holding i.e. the period between the purchase date and the date of transfer/sale.
Why- This helps to encounter erosion of value in the price of an asset and brings the value of an asset at par with the prevailing market price.
When- This cost inflation index factor is notified by the government every year.
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