Taxes again! We are sure your head is spinning after having dug up income information to file your returns last month. Few of you might be rolling your eyes “Nah! I can’t allow taxation to occupy anymore mind space.”
But history has been evident that the tax-filing period is the only time individuals think of taxation mistakes. Many learn their best tax-saving lessons during this time of the year, especially those who have to shell out additional taxes for lack of tax-saving knowledge.
You would have read much about salary income and how deductions could help you slash taxes. But what if you have received a sudden windfall amount or asset through inheritance? Are you liable to pay taxes on amount or asset received as inheritance? What if the inherited wealth hasn’t come from your lineal ascendants?
Many questions again buzzing in your head? Well, now you get why we thought of discussing the taxation impact on inherited wealth and the need to gauge when it is excused from the clutches of taxes. Proactively taking tax-saving measures could help you reduce the tax incidence, lest you are pushed to a higher tax bracket.
We know taxation could be complex to fathom. Hence we resorted to the case of a resident Indian family to understand taxation on inherited wealth.
Upon death of her uncle, Rashi, inherited a house, while her brother Alok received the financial assets – that included a fixed deposit, his senior citizen savings scheme (SCSS), mutual funds and public provident fund (PPF) amount. Alok’s younger sibling Ashish received the life insurance policy proceeds.
Calculating gains and paying due taxes would be fairly easy for Alok and Ashish. The life insurance money would come tax free to Ashish. Similarly, Alok wouldn’t have to bear any tax on the SCSS and the PPF money he has inherited, as it has come from a lineal ascendant.
FDs need to be given a closer look. If the FD account is closed and the proceeds handed over to Alok then he wouldn’t have to pay any taxes. However, if the fixed deposit is continuing and merely transferred to him, then he would be earning the interest and this interest amount won’t be tax free from the date of death. It would be added to his income and taxed as per his tax bracket.
So, the thumb rule for taxation linked to inherited assets is that it is received tax free in hand, but any gains, profits, rent or income made from those assets – physical or financial – is taxable in the hands of the receiver.
Let’s move to the tricky taxation trouble awaiting Rashi, who inherited the house in January 2010 and sold it in April 2016. She was not liable to pay tax on the house when she inherited it in 2010. But now that she sold it, she has made profits. These profits would be taxed in her hands.
However, not all the profits would be taxed. The actual taxable amount would depend on how long the property has been held – between both her uncle and after she inherited. Since her uncle bought it in 1989, she is considered to have held it for more than three years. Once a property is held for more than three years, gains qualify for a methodology called indexation, which is nothing but adjusting the purchase price for inflation. Apart from indexing the gains and thus reducing the profits based on purchasing power of money, she would be allowed to even deduct the cost that his uncle spent on acquiring it.
Again there are ways in which she can save taxes, here we mean the long-term capital gains tax which is applicable on assets held for more than three years. Now you know why we stressed on the number “3”.
If the entire amount of taxable profits Rashi earned on selling the inherited house is invested in another residential property in India, then she would be exempt from paying taxes (Section 54 of Income-tax Act). But this new property needs to be purchased within one year prior to sale date or two years from the sale date. For an under-construction property, a period of three years is permitted. During the period she is on the lookout for a property she can invest the gains in Capital Gains Account Scheme (CGAS) to save tax.
But, if Rashi sells the property before completion of three years between the original owner and herself then she would have to pay short-term capital gains tax, wherein the gains are added to her income and taxed at the slab rates applicable, apart from relevant surcharge and cess. This might result in the capital gains being charged to higher tax rate.
If Rashi doesn’t really wish to buy a house and yet wishes to save taxes then she can purchase certain government bonds using the profits from sale of the property. These bonds must be purchased within 6 months from the sale of the original house.
Before Rashi decides to purchase or construct a house or to purchase government bonds the tax implications need to be considered if she resides in some other country at the time of sale of the inherited property. Further she will also have to consider the inheritance tax implications applicable in the country of her residence.
This is all about gains, but what if Rashi decides not to sell the property at all? Can she just relax and enjoy the rent received on the property? Well, not really. In fact, if Rashi has already been owning another house before she inherited a property, irrespective of whether she earns any rental income or not she would have to pay tax for the rental income. This is because income tax rules consider a second home to be let out and hence a notional rent is considered for properties not let out.
Of course she can claim a standard deduction of 30% on the rental amount. Also if Rashi borrows money to renovate the inherited place, then she can claim a deduction of up to Rs 2 lakh on the interest amount paid.
Confusing? Just remember the thumb rule mentioned earlier. Inheriting assets not taxed, but income earned will be taxed. Then the rules are just as applicable on your regular income. Generally inheritance is a close family matter and if planned properly considering the tax implication in the hands of all the stakeholders it can result in great tax saving for the successors.
So look back at all the inherited assets and ensure you are building additional income on it in a tax-efficient way and declaring it at the right time. With the income tax department tracing tax evaders with the penalty wand you sure don’t want to end up on the wrong side of the law.