In computing capital gains on the sale of immovable property, the cost of acquisition of the asset is an important figure to be considered. This is required not only for computing the basic capital gain, but also for computing the exemption of long-term capital gains available for reinvestment in a residential house, where the cost of the new house is to be considered. The exact meaning of the term ‘cost of acquisition’ for capital gains purposes has not been defined, but has been effectively analyzed by the courts. acquisition costs
The cost of acquisition is not simply the original price paid to the seller. When you enter into an agreement to purchase an immovable property, you also agree to pay the stamp duty, registration fee and transfer fee (if applicable). These are of course part of the cost of acquisition. You may also pay expenses such as brokerage and legal fees. If these are directly linked to the transaction of purchase of the asset, they also form part of the cost of acquisition. Any GST on such expenses will also form part of the cost.
If you are buying a house that is under construction or to be built, you will pay GST on the purchase price, which will be part of the cost. In addition, you will pay various other amounts, such as legal fees, society formation fees, share capital contributions, clubhouse lump sum membership fees, electricity and gas deposits, and often, maintenance fees and taxes for the first year or Two. All these will be included under the cost of acquisition except the contribution of maintenance charges and taxes.
Often there is also the cost of renovating the property. If you have purchased a property on an open shell basis (with just walls and basic plumbing), expenses on civil works, flooring, wiring, etc., that are incurred to make the house habitable, will be part of the cost will be considered as acquisition. However, the cost of furniture will not be included even if it can be made and is not removable, such as cabinets and cupboards attached to the wall.
If you have previously purchased a house from someone who has lived in it, renovation expenses, such as replacing floors, tiles and bathroom fixtures, etc., cannot be considered as part of the acquisition cost, as the home was already habitable when you have achieved it. However, if you can demonstrate that the home was not habitable until such expense was incurred, it may qualify as part of the acquisition cost.
cost of improvement
Can such renovation expenses, which cannot be treated as part of acquisition cost, be treated as cost of improvement, which is also deductible in computing capital gains? For example, if the floor is replaced after a few years, can it be considered as the cost of the improvement? What if a balcony is attached and converted into a small room?
Generally, for an expense to be allowed as the cost of an improvement, it results in an increase in the asset, not just an increase in its life. Therefore, while the replacement of the floor would not qualify as the cost of the improvement, the creation of an additional room would.
Interestingly, interest on loan taken for home acquisition can also qualify as cost of acquisition. Of course, such expenditure is also eligible as deduction in computing the income from house property, and if so, the admissibility of such interest as cost of acquisition is liable to be challenged by the tax authorities on this ground. Highly likely that this is equivalent to a double deduction on equal interest.
If such interest is not claimed or allowed as deduction in any other year, the situation is far better, and such interest should be allowed as cost of acquisition.
Therefore, any decision to treat an expense as part of the acquisition cost has to be made after much thought and analysis.
Gautam Nayak is a Partner at CNK & Associates LLP.