Property Sale: When to consider as business income?

Selling multiple units, developer floors, or units from JDA? Does the tax come under capital gains or business income?

This document covers

Background
When to consider rent under Business Income ?
Tax treatment ?
Summary

1. Background

Trends in urbanisation continued at a rapid pace in India. More and more people redeveloping their real estate assets and getting them converted to multi-dwelling units. When selling such, does the income arise from the sale is considered as a capital gain or business income ?

2. When to consider as business income?

A particular asset will be treated as stock in trade or capital asset based on the manner in which it is held. The same item can be stock in trade in the hands of the taxpayer who deals in that item or capital asset if the taxpayer uses it for earning income or holds as an investment.

3. Tax treatment ?

The stock in trade may become capital asset in certain circumstances or vice versa.

If the real estate dealer retains the properties on closure of business or transfers some properties and holds as investment, those properties will become the capital assets in his hands.
If the investor wants to convert his capital asset into stock in trade, the same will be considered as stock in trade from the date of conversion. In this case, the capital gain will arise in the year of sale of converted asset but not in the year of conversion.

EXAMPLE:
Mr Rama purchased a land in May 2010 at a cost of Rs 35 lakhs for investment purpose. He started his real estate business on 01st Aug 2020 and converted the land into stock in trade of his business on 01st Aug 2020. Later he constructed a flat with a cost of Rs 10 lakhs on the land and sold it for Rs 1 crore on 15th Mar 2022. In this case

Computation of Capital Gains:
Capital gains will be taxable in the year in which the converted asset is sold i.e., 2021-22. For computation of capital gain, we need to consider the fair market value of the property on the date of conversion i.e., 01st Aug 2020.
1. Fair Market value on 01st Aug 2020 – 75,00,000
2. Less: Indexed COA (35 lakhs* CII for FY 2020-21/CII for FY 2010-11) = 35 lakhs * (301/167) = 63,08,383
3. Capital gain (i–ii) is Rs. 11,91,617
Computation of Business Income:
1. Sale price – 1 crore
2. Less: Cost of Flats – 15 lakhs
3. Less: Fair market value on date of conversion – 75 lakhs
4. Business income is Rs. 10 lakhs

In this case also, the intent of the taxpayer is important to show as business or Capital Gains.

4. Summary

If the taxpayer is investing in the properties with the investment purpose, he needs to show under capital gains and claim reinvestment option. Otherwise he needs to show as business income and claim expenses