How to calculate the cost of acquiring a new home
When calculating capital gains on the sale of real estate, an important figure to consider is the cost of acquiring the property. This is necessary not only for the calculation of basic capital gains, but also for the calculation of the long-term capital gains exemption available for reinvestment in a dwelling house, where the cost of the new house must be taken into account. The exact meaning of the term “cost of acquisition” for capital gains purposes has not been defined, but has been effectively analyzed by the courts. Cost of purchase
The cost of acquisition is not just the agreed base price to be paid to the seller. When you enter into a contract to purchase real estate, you also agree to pay stamp duty, registration fees and transfer fees (if applicable). These are certainly part of the acquisition cost. You may also pay expenses such as brokerage fees and legal fees. If these are directly linked to the purchase transaction of the property, they are also part of the acquisition cost. Any GST on these expenses will also be part of the cost.
If you buy a house under construction or to be built, you will pay GST on the purchase price, which will also be part of the cost. In addition, you would pay various other amounts, such as legal fees, company incorporation fees, share capital contribution, one-time clubhouse membership fees, electricity and gas deposit, and often, a deposit for maintenance costs and taxes for the first year or two. All these elements, with the exception of the contribution to maintenance costs and taxes, will be included in the acquisition cost.
There are also often building renovation costs. If you purchased a property on a bare basis (with only the walls and basic plumbing), the civil engineering, flooring, wiring, etc. expenses incurred to make the house habitable would be treated as part of of the cost of acquisition. The cost of furniture, however, would not be included, although it may be built-in and not removable, such as cabinets and wall-mounted cupboards.
If you bought a house from a person who previously lived in it, renovation expenses, such as replacing the floor, tiles, toilets, etc., cannot be considered part of the acquisition cost, because the house was already habitable when you acquired it. However, if you can show that the house was not habitable unless such expenses were incurred, they may be considered part of the cost of acquisition.
Can these renovation expenses, which cannot be treated as part of the acquisition cost, be treated as improvement costs, which are also deductible in calculating capital gains? For example, if the flooring is replaced after a few years, can it be treated as an improvement cost? What if a balcony was closed and transformed into a small room?
Normally, for an expense to be allowed as an improvement cost, it must result in an improvement to the asset, not just an increase in its lifespan. Therefore, while replacing the flooring would not be considered an improvement cost, creating an additional room would be.
Interestingly, the interest on a loan taken out for the acquisition of the house can also be considered acquisition costs. Of course, such expenses can also be deducted in the calculation of income from home ownership and, in this case, the admissibility of such interest again as an acquisition cost is likely to be disputed by the tax administration on the grounds that it is a double deduction for the same interest.
If this interest has not been claimed or allowed as a deduction in another year, the situation is much better and this interest should be eligible as an acquisition cost.
Therefore, any decision to treat an expense as part of the cost of acquisition should be made after careful consideration and analysis.
Gautam Nayak is Partner, CNK & Associates LLP.