Sridhar, a leading advocate, brought an interesting tax situation to me, for his cousin Ms Nirmala. Before I get into the details of the issue involved, let me explain a little regarding the background. Nirmala left India almost 15 years ago with her husband and settled in the United States. She became a naturalised American Citizen, and is also a PIO cardholder by virtue of her Indian origins and connections. She received a house property at Bangalore from her mother as a gift in 2010, and wants to sell it.
Her mother inherited this property through the will, after the demise of her husband in 2009, and the property was originally constructed in 1980. The expected sale value of the gift was Rs 1.20 crore. She wanted to know what the legal and tax ramifications would be in India as well as USA, for sale as well as repatriation. Having received a gift for the US-living non-resident Indian is a bonanza, more so at a time when the US economy is reeling under recession. But wait, look at the challenges.
There is no doubt that the gift received in India from the mother is an exempt gift, as it falls under the definition of Sec 56(1) of the Indian Income-Tax Act. However, the profits on the sale of the property are subject to capital gains tax. As per section 49(1) of the Income-Tax Act, the period of holding the property dates to the time when her father started owning the property, since it was an inheritance by her mother, and subsequently a gift to Nirmala.
Therefore, the asset is a long-term capital asset (more than 36 months) and hence 20 per cent long-term capital gains tax has to be paid by her for the gains portion. The capital gains portion has to be computed by reducing the indexed cost of acquisition from the sale price. Now, while adopting the indexed cost of acquisition, the tax payer faces the anomaly. Contrary to the logical treatment of indexing the cost of acquisition, which should be capable of being imperatively inferred from the year of acquisition, i.e.1980-81, she would get indexation only from 2010-11, being the first year in which she held the asset.
This anomaly arises on account of the fact that the definition doesn't provide for indexing from the year in which the previous owner held the asset.
In other words, instead of having cost of indexation at 711 for the year 2010-11, she would get indexation as 100, which is for 1981-82. The tax liability is huge in India…Isn't it? Let us look at her tax implications in the US, it being her resident country. As a US citizen and resident, Nirmala needs to include her global income in the US and comply with the tax laws of America.
THE US CONTEXT
The said house sale in India is “real property held for investment” to use US tax jargon, and therefore any loss/gain is reportable and gain is taxable.
You need to know the price you sold it (or are planning to sell it for) and the cost you bought it for. Of course, we do remember you didn't buy this. So how do we arrive at the cost basis? Here comes the twist in the tale: To figure out what is your basis (cost) in the property received as a gift, you must know both the donor's basis, as well as the fair market value (FMV) of the property, at the time the gift was given to you.
If the FMV at the time of the gift is less than the donor's basis, your basis depends on whether you have a gain or loss on the actual sale. To state it simply, if you have gain on sale, your basis will be the same as the donor's basis, and if you have a loss, your basis is the FMV of the property at the time of gift. “Adjusted basis” is cost, plus any improvements or any reductions to value of property, during the time you hold it or the donor held it. You may take credit for the taxes paid in India while arriving at your tax liability in USA as per DTAA.
It doesn't stop with this. You need to file an information report in Form 3520 for having received the gift in India, failing which penalty proceedings would await. If you wish to repatriate the money to USA, you need to comply with the RBI formalities and transfer the funds. If you don't wish to repatriate the proceedings but prefer to keep it in India in a bank or mutual funds or shares, the reporting requirements in FBAR format have to be done before June 30 each year. The failure of complying this will result in $10000 per incident.
To figure out the basis cost for the property, you must have both the donor's basis, as well as the fair market value, at the time of gifting.