When calculating capital gains from the sale of immovable property, one important figure to consider is the cost of purchasing the property. This is required not only to calculate the base capital gains, but also to calculate the long-term capital gains exemption available for reinvestment in a residential home, as the cost of the new home must be considered. The exact meaning of the term “purchase cost” has not been established for capital gains purposes, but has been actively analyzed by the courts. Purchase cost
Purchase cost is not only the basic price agreed to be paid to the seller. When you enter into an agreement to purchase a property, you also agree to pay stamp duty, registration fee, and transfer fee (if any). These certainly form part of the purchase cost. You may also pay expenses such as brokerage and legal fees. If these are directly related to the property purchase process, they also form part of the purchase cost. Any GST on these expenses will also form part of the cost.
If you are buying a home that is or is to be built, you will pay GST on the purchase price, which will also form part of the cost. Besides, you’ll pay various other amounts, such as legal fees, community formation fees, capital contribution, one-time club membership fees, electric and gas deposit, and often, a deposit of maintenance fees and taxes for the first year or two. All of these, except for a contribution to maintenance fees and taxes, will be included in your purchase cost.
There is often a cost to renovate the property. If you have purchased a property on a chance basis (with walls and basic plumbing only), the expenses for civil works, flooring, wiring, etc., that are incurred to make the home habitable will be treated as part of the acquisition cost. However, the cost of furniture will not be included, although it may be built-in and non-removable, such as cupboards and cupboards attached to the walls.
If you purchased a home from someone who lived in it earlier, renovation expenses, such as replacing floors, tiles, bathroom fixtures, etc., may not be treated as part of the purchase cost, since the home was already habitable when you got it. However, if you can prove that the house was not habitable unless such expenses were incurred, it may qualify as part of the purchase cost.
Can this renewal expense, which cannot be treated as part of the purchase cost, be treated as an improvement cost, which can also be deducted in the capital gains account? For example, if floors are replaced after a few years, can it be treated as an improvement cost? What if the balcony was closed and turned into a small room?
Usually, for the expense to be allowed as an improvement cost, it must lead to an enhancement of the asset, not merely an increase in its life. So, while replacing the flooring wouldn’t qualify as an improvement cost, creating an additional room would.
Interestingly, the interest on the loan taken out to purchase the home may also qualify as an acquisition cost. Of course, such an expense also qualifies as a deduction in the income from home ownership account, and if so, the tax authorities would very likely object to allowing that interest again as an acquisition cost on the grounds that it amounts to a double deduction for the same interest.
If this interest is not claimed or allowed as a deduction in any other year, the situation is much better, and this interest should be allowed as an acquisition cost.
Therefore, any decision to treat the expense as part of the purchase cost must be taken after much thought and analysis.
Gautam Nayak is a Partner, CNK & Associates LLP.