CAPITAL GAINS ON SALE OF LAND AND BUILDING – COST OF CONSTRUCTION FOR ADDITION AND ALTERATIONS IS COST OF IMPROVEMENT OF CAPITAL ASSET

[CA DEV KUMAR KOTHARI]

Main relevant provisions:

Section 2, 45, 48, 55 of the Income-tax Act, 1961 and other related provisions for incentives, exemptions etc.

Land held as long-term capital asset:

Investment in land is generally very long-term investment. Acquisition and holding of land for long period is an adventure in nature of commerce as opposed to adventure in nature of trade. Land is generally ‘capital asset’, unless it is purchased for trading purposes and is held as stock-in-trade.

Building held as  capital asset:

Building is also a capital assets unless it is treated and / or held as stock-in-trade. Even buildings used in business on which depreciation is allowed are treated capital assets, and in case of transfer of any building for computing income, if any, provisions for computation of ‘capital gains’ are applicable with some special modification. However gains is to be ascertained under the head ‘capital gains’.

Land and Building:

Building constructed on land is attached to it and is part of land. After construction of a building the property which was only land earlier becomes a composite property called  ‘land and building’. Without land, or proportionate share in land, any building or any portion of building has no existence,  and for transfer of ownership or rights in building  ownership or some rights in land is essential. 

After construction of building on land the property has to be sold as land and building.

Building cannot be sold without land. Therefore, for selling building or any portion or part of it, land or proportionate share in land or some rights in land or proportionate share in land  is also to be  transferred.

If a buyer want to purchaser vacant land the building has to be demolished if requirement of buyer is agree.

If owner want to sell vacant land he can demolish building and can   sell components or  parts    like doors and windows, usable fittings, separately and scrap of building. In this case there is no sale of land and building but sale of land after making it plain and vacant.

Building is in nature of addition to land:

By construction of building on any piece of land, there are additions to capital asset in form of land. The capital asset which was only land becomes land and building, after construction is put on it. Even land appurtenant to building, though vacant is part of land and building. More construction on the building or in nearby vacant land will make more addition.

Segregation of cost is due to different nature and reasons

Generally land is not a depreciating assets it is assumed to be non-destructible. Though in some exceptional circumstances land may also destruct due to change in its character due to natural factors, and usages. For example a volcano or earth quake can in some situations change character of land. In case of agricultural land, over a long period of use without rehabilitation fertile land can become barren land. This can be considered a form of wear and tear or land also though land remain.

 Whereas building is a depreciating asset due to usages, efflux of time and obsolescence etc. which causes wear and tear or can result into building becoming unsuitable.

In tax laws also building may be eligible for depreciation allowance, whereas land is not eligible for depreciation allowance.

In accounts cost of land and cost of building thereon can be segregated and should preferably be segregated. This is done for the purpose of ascertainment of depreciation on building separately. This is also required as per generally accepted accounting policies.

In practice we find that at the time of sale, value of land and building was generally not segregated in conveyance deed, even in case of ownership apartments combined amount was mentioned and there was no bifurcation for proportionate share in land and common facilities.

 Only during last few years some vendors have adopted practice of mentioning consideration for land and building separately. Now in view of GST it is preferred to have separate figures for land and building.

 

Cost of building as cost of improvement of land:

In case a capital asset is acquired as land and building the cost of acquisition of land and building will be considered. However, when after acquisition of land, building is constructed, then the date of acquisition of land will determine its character of short term or long-term capital assets. The construction cost shall be in nature of additions and improvement.

As observed above, if land is held as capital asset, after construction,  ‘ land and building’ will also be capital asset. Construction of cost is nothing but addition on land and it is in nature of value addition to capital asset.

Sale of land and building:

When a land and building is sold which is held as ‘capital asset’, we need to make computation of income under the head “Capital gains”, in accordance with provisions applicable from Section 45- 55A.

Charging section and computation provision:

Section 45 is charging section and section 48 is computation provision for computing capital gains.

 Relevant portion of provision is given below, in left column of table  with suitable modification and highlights for understanding of present subject matter of computation of capital gains in case of sale of capital asset being land and building:

E.-Capital gains

From provisions:	Remarks and observations
Capital gains.
45. 1[(1)] Any profits or gains arising from the transfer of a capital asset effected in the previous year shall, save as otherwise provided in sections 2[***] 3[54, 54B, 4[***] 5[6[54D, 7[54E, 8[54EA, 54EB,] 54F 9[, 54G and 54H]]]]], be chargeable to income-tax under the head "Capital gains", and shall be deemed to be the income of the previous year in which the transfer took place.	Capital asset is  land and building.
1[Mode of computation.
48. The income chargeable under the head "Capital gains" shall be computed, by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset the following amounts, namely :-	Full value of consideration for land and building is to be considered.
(i) expenditure incurred wholly and exclusively in connection with such transfer;
(ii) the cost of acquisition of the asset and the cost of any improvement thereto
Provided further that where long-term capital gain arises from the transfer of a long-term capital asset, other than capital gain arising to a non-resident from the transfer of shares in, or debentures of, an Indian company referred to in the first provi­so, the provisions of clause (ii) shall have effect as if for the words "cost of acquisition" and "cost of any improvement", the words "indexed cost of acquisition" and "indexed cost of any improvement" had respectively been substituted:
Explanation.-For the purposes of this section,-
(iii) "indexed cost of acquisition" means an amount which bears to the cost of acquisition the same proportion as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the first year in which the asset was held by the assessee or for the year begin­ning on the 10[ 1st day of April, 2001 ], whichever is later;
(iv) "indexed cost of any improvement" means an amount which bears to the cost of improvement the same proportion as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the year in which the improvement to the asset took place;
5[(v) "Cost Inflation Index", in relation to a previous year, means such Index as the Central Government may, having regard to seventy-five per cent of average rise in the 6[Consumer Price Index (Urban)] for the immediately preceding previous year to such previous year, by notification in the Official Gazette, specify, in this behalf.]]
Meaning of "adjusted", "cost of improvement" and "cost of acquisition". 55. (1) For the purposes of 1[sections 48 and 49],-
3[(b) "cost of any improvement",-
(2) in relation to any other capital asset,-] (i) where the capital asset became the property of the previous owner or the assessee before the 33[ 1st day of April, 2001 ]], 8[***] means all expenditure of a capital nature incurred in making any additions or alterations to the capital asset on or after the said date by the previous owner or the assessee, and (ii) in any other case, means all expenditure of a capital nature incurred in making any additions or alterations to the capital asset by the assessee after it became his property, and, where the capital asset became the property of the assessee by any of the modes specified in 9[sub-section (1) of] section 49, by the previous owner, but does not include any expenditure which is deductible in computing the income chargeable under the head "Interest on securities", "Income from house property", "Profits and gains of business or profession", or "Income from other sources", and the expression "improvement" shall be construed accordingly.
2) 10[For the purposes of sections 48 and 49, "cost of acquisition",-
(b) in relation to any other capital asset,-] (i) where the capital asset became the property of the assessee before the 34[ 1st day of April, 2001 ] ], means the cost of acquisition of the asset to the assessee or the fair market value of the asset on the 35[ 1st day of April, 2001 ]], at the option of the assessee ; (ii) where the capital asset became the property of the assessee by any of the modes specified in 24[sub-section (1) of ] section 49, and the capital asset became the property of the previous owner before the 36[ 1st day of April, 2001 ]], means the cost of the capital asset to the previous owner or the fair market value of the asset on the 37[ 1st day of April, 2001 ]], at the option of the assessee ; (iii) where the capital asset became the property of the assessee on the distribution of the capital assets of a company on its liquidation and the assessee has been assessed to income-tax under the head "Capital gains" in respect of that asset under section 46, means the fair market value of the asset on the date of distribution ;

Before examining aspect relating to capital gains on transfer of land and building it is necessary to understand meaning of capital asset the meaning is given in definition clause in section 2 of the Income-tax Act, relevant portion is extracted below:

Capital asset:

Definitions.

     2. In this Act, unless the context otherwise requires,-

(14) “capital asset” means-

           (a) property of any kind held by an assessee, whether or not connected with his business or profession;

          (b)  xxx

but does not include-

               (i) any stock-in-trade [other than the securities referred to in sub-clause (b)],],; consumable stores or raw materials held for the purposes of his business or profession

 

On analysis we find that  land and or building  being  property of some  kind  will be   a capital asset,  unless  it is  stock-in trade of assesse.

As discussed earlier, land is generally a very long-term investment and therefore capital asset.

Even a developer of properties can acquire land and held it as a long-term capital asset. He may have objective of developing land and selling at profit, but still the land is capital asset and it is not his stock-in-trade.  Stock-in-trade is an item which is sold in day to day business and without any major changes. If a property is to be held for fairly long-period and some improvements are to take place or improvement are to  be made then it will be a case of capital asset. 

Only when a person buy and sell land within short periods as a trader then only land can be stock-in-trade.

Land cannot in any case be regarded as consumable stores or raw materials held for the purposes of  business or profession

Therefore, when land is purchased for long-term holding, improvement and then selling it will be a case of holding it as capital asset.

Acquisition , holding and improvement  of land and / or buildings can be a business being adventure in nature of commerce. Such land and building in course of such adventure will be capital asset of such business.

Only when any land and or building is acquired and held for simple trading purposes  as an adventure in nature of trade where such land and buildings are sold within very  short period and maximisation of turnover and turnover ratio is target, then only it can be said that land and building are held as stock-in-trade.

Provisions in relation to land and building and capital gains:

On reading of above provisions we can analyse applicability in relation to land and building as follows:

1. When a capital asset was acquired as land and building, the date of acquisition of such land and building will be date of acquisition and cost incurred will be cost of acquisition. If after acquisition more area is

constructed it will be in nature of additions and improvement, if  old construction is improved then also it can be addition and / or alteration and thus improvement. Therefore, in such cases allowable costs will be cost of acquisition and cost of improvement. In case original asset is long-term then benefit of cost inflation index (CII) shall be allowed in respect of cost of acquisition and cost of improvement both. Cost of improvement shall be inflated for each year in which improvement took place or cost was incurred.

2. If original capital asset was acquired only as land and thereafter building or buildings are constructed the construction of building is addition and is improvement to the original capital asset that is land. The date of acquisition of land will be relevant for determining character as long-term or short-term capital asset being land and building. Cost of additions by construction of buildings will be cost of improvement of original asset that is building. 
3. In case original asset is long-term, cost of improvement is eligible for inflation with CII according to the year in which cost of improvement was incurred and the year of transfer. Therefore, if improvement took place in one year and transfer took after end of FY in which improvement took place, the benefit of CII will be eligible.
4. If any expenditure has been allowed, under any other head, then such expenditure will not be eligible as cost of improvement.