Cost of improvement for computation of capital gains

Introduction

Any capital expenditure incurred by the assessee to make any addition or improvement in an existing capital asset is treated as 'cost of improvement'. Resident individuals and resident HUFs can choose to avail the benefit of indexation and replace cost of improvement with 'Indexed Cost of Improvement' while computing long-term capital gain in respect of land or building (or both) acquired before 23-07-2024.

1. About

Any profit or gain arising from transfer of a capital asset is taxable under the head capital gains. Such capital gain is computed in the following manner:

2. How to calculate cost of improvement?

2.1. In General

'Cost of Improvement' means all expenditure of a capital nature incurred on or after 01-04-2001 in making any addition or alterations to the capital asset either by the assessee or the previous owner. Therefore, all capital expenditure incurred on or after 01-04-2001 shall be deducted while calculating the capital gains.

However, cost of improvement shall not include such expenditure which is deductible in computing the income chargeable under the head 'Income from House Property', 'Profits and Gains of Business or Profession', or 'Income from Other Sources'.

Further, where the capital asset is a house property, the interest claimed under Section 22(1)(b) or Chapter VIII (i.e. Section 130 and Section 131) shall not be considered part of the cost of improvement of such house property.

2.2. Cost of improvement of asset acquired before 01-04-2001

If a capital asset is acquired by the previous owner or assessee before 01-04-2001, any cost of improvement incurred before that date shall be ignored. In other words, the cost of improvement of a capital asset acquired before 01-4-2001 shall include only that capital expenditure which are incurred on or after 01-04-2001.

2.3. Cost of improvement of asset acquired from previous owner

Where a capital asset became the property of the assessee in any of the circumstances as referred to in Section 73(1) [Table S. No. 1], the cost of improvement shall include any expenditure of capital nature incurred on or after 01-04-2001 by the previous owner or assessee in making any additions or alterations to the capital asset.

2.4. Cost of improvement in case of Intangibles

The cost of improvement in relation to the following asset shall be taken to be nil:

(a) Goodwill or any other intangible asset of a business;

(b) Right to manufacture, produce or process any article or thing;

(c) Right to carry on any business or profession;

(d) Any other right.

3. Indexed cost of improvement

3.1. What is Indexation?

Indexation is the process of adjusting the actual cost of acquisition and cost of improvement of a capital asset in order to neutralise the impact of inflation over time. The indexation process ensures that a taxpayer pays capital gain tax on the real or actual gain and not on an increase in the capital value of property due to inflation. This is the object or purpose of indexation.

3.2. Is indexation allowed under the Income-tax Act?

The indexation was traditionally allowed under the Income-tax Act when calculating long-term capital gain unless specifically restricted. However, the Finance (No. 2) Act, 2024 removed the indexation benefit and introduced a uniform tax rate of 12.5% on long-term capital gains under ITA 1961 to simplify the computation of capital gains.

However, to ease the transition, the Government introduced a grandfathering provision which provides a specific relief to resident individuals and resident HUFs in respect of land or building (or both) acquired before 23-07-2024. In such cases, the taxpayer has the option to compute tax either:

(a) at 12.5% without indexation benefit; or

(b) at 20% after claiming indexation benefit.

This simplified framework has also been continued under ITA 2025.

3.3. How indexation is allowed under the Income-tax Act?

When there is a long-term capital gain from the transfer of a long-term capital asset, the "Indexed Cost of Acquisition" and the "Indexed Cost of Improvement" are used to compute the capital gain instead of the original cost of acquisition and improvement. This ensures that the impact of inflation is considered when calculating taxable gains. It is be noted that the indexation benefit is allowed only to resident individuals and resident HUFs for land or building acquired before 23-07-2024, as discussed earlier.

3.4. How to calculate indexed cost of improvement?

3.4-1. In general

The Indexed cost of improvement shall be calculated in two-steps. The first step is to calculate the cost of improvement of capital asset. In the second step, such cost of improvement is multiplied with the CII of the year in which capital asset is transferred and divided by CII of the year in which cost of improvement is incurred.

3.4-2. Indexation in case of acquisition from previous owner

Where a property is acquired under any circumstances given in Section 73(1) [Table S. No. 1], the indexed cost of improvement shall be calculated as follows:

4. Notified Cost Inflation Index (CII)

The indexation of cost of improvement shall be done on the basis of following notified Cost Inflation Index:

References

Resident individuals and HUFs may opt for the benefit of indexation while computing long-term capital gains arising from the transfer of land or building acquired before 23-07-2024, where the tax without indexation exceeds the tax computed with indexation.

Resident individuals and HUFs may opt for the benefit of indexation while computing long-term capital gains arising from the transfer of land or building acquired before 23-07-2024, where the tax without indexation exceeds the tax computed with indexation.

Notification No. SO 3266(E) [No. 63/2019 (F. No. 370142/11/2019-TPL)], Dated 12-9-2019

Notification No. SO 1790(E) [No. 32/2020 (F. No. 370142/17/2020-TPL)], Dated 12-6-2020

Notification No. 73/2021, [F. No. 370142/10/2021-TPL], Dated 15-06-2021

Notification No. 62 /2022/F.No.370142/20/2022-TPL], Dated 14-06-2022

Notification No. 39/2023, dated 12-06-2023

Notification No. 44/2024, dated 24-05-2024

Notification No. 70/2025, dated 01-07-2025

This article is general information and not tax advice. Provisions change. Confirm your position with a qualified professional before acting.