Indexed cost of acquisition for computation of capital gains

Introduction

'Indexed cost' allows a higher deduction in respect of cost of acquisition to neutralize the effect of inflation. The cost of acquisition is indexed in accordance with the notified Cost Inflation Index (CII) for the year of sale and year of acquisition. The indexation benefit is available only when the asset is a land or building acquired before 23-07-2024 by the resident individual or resident HUF.

1. About

1.1. What is Indexation?

Indexation is the process of adjusting the actual cost of acquisition 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.

1.2. 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.

1.3. 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.

The long-term capital gain with indexation is computed as follows:

2. How to calculate Indexed cost of acquisition?

2.1. In general

The Indexed Cost of acquisition shall be calculated in two-steps. The first step is to calculate the cost of acquisition of capital asset. In the second step, such cost of acquisition is multiplied with the CII of the year in which capital asset is transferred and divided by CII of the year in which asset is first held by the assessee or CII of 2001-02, whichever is later.

2.2. Indexation in case of acquisition from previous owner

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

It is to be noted that the assessee and revenue are in dispute on the issue of CII to be taken in denominator. Whether it should be of the tax year in which previous owner has acquired it or of the tax year in which assessee acquires it by way of a mode as specified above.

The Delhi High Court

2.3. Indexation in case of conversion into stock-in-trade

If a capital asset is converted by the owner thereof into, or is treated by him as, stock-in-trade of a business carried on by him, it shall be deemed that the capital asset is transferred during the tax year in which such conversation took place and capital gain is computed accordingly.

In such a case, the indexation of the cost of acquisition of the capital asset shall be computed taking the Cost inflation index (CII) of the year in which such capital asset is converted into stock-in-trade. CII of the year in which stock-in-trade is sold, is not relevant even though capital gain in such case is taxable in the year in which stock-in-trade is sold.

2.4. Indexation in case of compulsory acquisition

If a capital asset is compulsorily acquired by the Government, or where the consideration for such transfer is to be determined or approved by the Government or the Reserve Bank of India, it shall be deemed that the capital asset is transferred during the year in which compulsory acquisition has taken place. However, the capital gain is chargeable to tax in the year in which the compensation is first paid.

In such a case, the indexation of the cost of acquisition of the capital asset shall be computed taking the CII of the year in which the capital asset is taken over by the government and not of the year in which compensation is paid.

3. Notified Cost Inflation Index (CII)

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

References

Arun Shungloo Trust v. CIT [2012] 205 Taxman 456 (Delhi)

CIT v. Manjula J. Shah [2012] 204 Taxman 691 (Bom.)

CIT v. Gautam Manubhai Amin [2013] 218 Taxman 319 (Guj.) and CIT v. Rajesh Vitthalbhai Patel [2013] 218 Taxman 301 (Guj.)

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.