Indexation

Tax

Quick Definition

Indexation is a method used to adjust the purchase price of an asset for inflation, reducing the taxable capital gain.

Detailed Explanation

Indexation increases the cost of acquisition of an asset based on inflation, which lowers the capital gain and hence reduces tax liability.

In India, indexation is applied using the Cost Inflation Index (CII) under the Income Tax Act 1961.

Formula

👉 Indexed Cost = Original Cost × (CII of Sale Year ÷ CII of Purchase Year)

Why Indexation Matters

  • Reduces taxable capital gains
  • Accounts for inflation impact
  • Encourages long-term investment

Where It Is Used

  • Real estate (property sale)
  • Debt mutual funds (in earlier tax rules)
  • Long-term capital assets

Indexation vs Non-Indexation

  • With Indexation: Lower tax due to inflation adjustment
  • Without Indexation: Higher taxable gains

Example

"<ul> <li>Purchase price = ₹10 lakh (CII = 200)</li> <li>Sale price = ₹20 lakh (CII = 300)</li> </ul> <p>👉 Indexed Cost = 10 × (300/200) = ₹15 lakh<br /> 👉 Taxable Gain = ₹5 lakh (instead of ₹10 lakh)</p>"

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