Income Tax Department sets cost inflation index for FY 2025-26, key for LTCG tax

The Income Tax Department has officially announced the Cost Inflation Index (CII) for the financial year 2025-26. This index, set at '376', is a critical component in the calculation of long-term capital gains (LTCG) on asset sales. The CII is utilised to adjust the purchase price of long-term assets to account for inflation, thereby helping taxpayers manage their taxable profits and, in turn, their tax liabilities. This announcement was made on July 1, 2025, and it is essential for taxpayers dealing with long-term capital assets.

Long-term capital assets are recorded at their initial cost, and despite inflation, they are not revalued in financial records. When these assets are sold, the resulting profit is typically high due to the increased sale price compared to the original cost. The CII applies to these assets, inflating the purchase cost to reduce taxable profits. As a result, taxpayers benefit from a lower tax burden. The CII benefits those selling long-term capital assets, as it reduces the capital gains tax liability by adjusting the asset purchase price for inflation.

The CII's significance lies in its application for calculating LTCG, especially under changing capital gains rules. Although recent changes removed indexation benefits from most assets, these benefits still apply to house properties under certain conditions. Specifically, if a house was acquired on or before July 22, 2024, and sold on or after July 23, 2024, homeowners can select between the old and new tax rules. The old rule calculates tax at 20% with indexation, while the new rule uses a 12.5% rate without indexation.

For this financial year, homeowners selling properties acquired before the specified date will require the current CII to compute their LTCG with the indexation benefit. This provides an opportunity to potentially lower their tax obligations by considering inflation in asset valuation, thus aligning with the CII's purpose to adjust for inflationary effects.

The process of using the CII involves a formula: Inflation-adjusted price = (CII of the year of sale / CII of the year of purchase) * Actual purchase price of the asset. For example, if a house was purchased in FY 2002-03 for Rs 30 lakh, its inflation-adjusted price in FY 2025-26 would be calculated as (376/105) x Rs 30 lakh, equaling Rs 1,07,42,857.14.

The base year concept in the Cost Inflation Index is pivotal, as it establishes a benchmark for evaluating inflation across different financial years. The base year holds an index value of 100, facilitating comparisons with other years to determine inflationary increases. This mechanism allows taxpayers to apply indexation benefits effectively, using the higher value between the 'actual cost or Fair Market Value (FMV) as on the 1st day of the base year. Indexation benefit is applied to the purchase price so calculated. FMV is based on the valuation report of a registered valuer.'

The CII's updated figure of '376' will become effective on April 1, 2026. It will be instrumental in computing the indexed cost of acquisition for assets sold within the financial year, ensuring that the effects of inflation are accurately represented in financial and tax calculations. This update by the Income Tax Department underscores the importance of the CII in facilitating fair taxation for long-term capital assets, aligning tax calculations with current economic conditions.

In conclusion, the CII serves as a vital tool for taxpayers, providing a means to mitigate tax liabilities through inflation-adjusted asset valuations. Its role in LTCG calculations remains integral, particularly amidst evolving tax rules, ensuring that taxpayers have the capacity to make informed financial decisions while adhering to regulatory requirements.