✅ Budget Gives a Realty Check

Welcome to this week’s Altsights!

Budget 2024 was announced a couple of days ago and let’s just say that the market is not very happy about it.

A bunch of changes (rationalisation) were made in the capital gains treatment of various assets.

Realty Check 🏠

Here’s what has changed for real estate:

Before we can assess the impact of these changes (which are intriguing), we must understand ‘indexation.’

Understanding Indexation 👨🏻‍🏫

Suppose you purchased an asset for ₹100 some years ago and sold it today for ₹200. 

Now, some of this price increase is due to inflation. Let’s suppose that ₹60 gain is because of inflation or general rise in prices.

Indexation says that you should pay tax only on the gain that is due to the asset’s price appreciation (₹40 here) and the gain not due to inflation.

This means you will pay tax only on ₹40 and not the entire ₹100 gain.

No wonder indexation is referred to as a benefit!

20% with Indexation vs. 12.5% Flat ⚖️

While the budget has proposed a lower tax rate on LTCG, it is not necessarily good news for urban real estate investors because of the loss of indexation benefit.

You see, prices in urban areas have not appreciated much in recent times. Jaipur is a prime example of this.

As per the RBI’s house price index, the market value of a house purchased in Jaipur in 2010 for ₹50 lakh would be about ₹85 lakh today.

While the ₹35 lakh profit looks good on paper, it is just a 3.9% annual growth rate.

Here’s how the removal of indexation works against a low growth rate of 3.9%:

So, instead of registering a ₹14 lakh loss (and paying no tax), the owner of this real estate would have to pay a tax of ₹4.4 lakh with the new tax rules.

The Other Side of the Story 🐢

While real estate price growth in Jaipur lagged the inflation rate, it exceeded the inflation rate in Lucknow.

As per the RBI’s house price index, the market value of a house purchased in Lucknow in 2010 for ₹50 lakh would be about ₹2.35 crore today. That’s an annual growth rate of 10.7%.

Here’s how removal of indexation works in favour of a high growth rate of 10.7%:

As you can see, the owner of this real estate is better off by about ₹4 lakh thanks to the change in LTCG tax rate and removal of indexation.

However, this is not the base case for most urban real estate investors today. Price growth rates in most cities have lagged or managed to just about match the inflation rate.

Let’s not forget the extra interest cost investors pay when they take a home loan and other costs of a real estate transactions. These costs add up.

Fintwit (the finance twitter community) strongly criticised the following post by the Income tax department yesterday:

As per the RBI’s all-India house price index, the average growth rate in real estate across the 10 major cities has been just about 8.5% in the last 14 years. 

Note - The loss of indexation and lower LTCG rate of 12.5% is applicable only on real estate purchased in 2001 or later. Real estate purchased prior to 2001 will enjoy(?) the old LTCG tax rate of 20% with the benefit of indexation.

Does this Mean Real Estate is Bad Now? 💭

Not really. Buying a home for your family is not just an aspiration of every Indian but also a good decision in my view.

However, buying residential real estate in urban areas for price appreciation or rental yield are questionable choices.

For rental yields: I discussed earlier this month that commercial real estate works out to be much better and reliable than residential real estate. You can read all about it here - https://altsights.altcase.com/p/20-rise-rents-commercial-properties.

For price appreciation: Since real estate doesn’t have the luxury of indexation anymore, investment with poor returns will not be spared anymore. Recall the poor Jaipur real estate investor. Only if your real estate returns beat the inflation rate comprehensively, will the new tax rules favour you.

But let’s not forget the other advantages real estate still enjoys:

• You can invest and avail tax exemption on long-term gains from capital assets (like stocks and mutual funds) if you invest them into a house under section 54F

• You can offset home loan principal against your salary under section 80C

• You can offset home loan interest against your salary under section 24

• Home loan rates are among the lowest across all types of loans

• Rental income enjoy a 30% standard deduction and only 70% is taxed

Reader’s Spotlight💡

A few of you asked me about my expectations from the budget. Unfortunately, I can’t answer those queries now as the budget is out there.

Here’s my review of the budget though:

• The fiscal prudence focus of this government has been excellent and continues to be so.

• The focus on ‘inclusive’ economic growth is clear.

• Much needed initiatives on employment and upskilling.

• Middle class got some much needed relief in taxation with the modification in tax slabs and increase in standard deduction.

• But the upper middle class and affluents are rightly miffed with the increase in equity taxation.

• Overall, the simplification of the capital gains taxation structure is a step in right direction.

Do you have any questions for me this week?

Simply reply to this email with your question and I’ll answer it for everyone in the next issue.

Cheers,
Madhu,
Founder, Altcase