Understanding Cost of Improvement in Capital Gains
Capital Gains = Sale Consideration – (Cost of Acquisition + Cost of Improvement + Transfer Expenses)
In this blog, we’ll explain what qualifies as cost of improvement while calculating capital gains under the Income Tax Act, 1961.
What is Cost of Improvement?
As per Section 55(1)(b) of the Income Tax Act, cost of improvement refers to capital expenditure incurred in making any additions or alterations to a capital asset after acquisition.
Key Conditions:
- Must be capital in nature (not routine maintenance or repairs)
- Incurred by the assessee or previous owner (for inherited/gifted assets)
- Only allowed for long-term capital assets (held more than 24/36 months)
Allowed Expenses as Cost of Improvement
Here are common examples that qualify:
| Type of Asset | Allowed Expenses |
|---|---|
| Land/Building | – Construction of additional floors or rooms – Major renovations or structural changes – Boundary walls, underground tank, borewell – Legal fees for land conversion or approvals |
| Equity Shares | Not applicable (no cost of improvement allowed as per Sec 55(2)(aa)) |
| Mutual Funds | Not applicable (same as above) |
| Other Assets (like Jewellery) | Generally, no cost of improvement unless structural transformation is made (rare) |
What is Not Allowed?
- Whitewashing, painting, plumbing
- Regular repairs or maintenance
- Property tax, utility bills
- Expenses claimed under other heads (e.g., Section 24 for house property)
Special Cases: Inherited or Gifted Property
📌 Example:
You inherited a property from your father, who constructed an additional floor in 2008. You can include that expenditure as cost of improvement even though you didn’t spend it.
Indexed Cost of Improvement
Indexed Cost = Actual Cost × (CII of year of sale / CII of year of improvement)
This adjustment for inflation reduces the capital gains tax burden.
Expert Tip: Keep Proofs Handy
Maintain these to defend your claim:
- Receipts of materials/labour
- Invoices of contractors
- Municipal approvals or completion certificates
- CA-certified computation sheet if needed
If you’re unable to produce proof, the Assessing Officer may disallow your claim during scrutiny.
Legal Reference
- Section 55(1)(b) of the Income Tax Act, 1961
- ITAT Judgments: Various rulings have upheld inclusion of genuine structural improvements backed by documentation
FAQs on Cost of Improvement
Q1. Can I include cost of furniture in a flat?
No, movable assets like furniture are not considered part of the capital asset structure.
Q2. Can I claim cost of improvement in short-term capital gains?
Only if incurred after acquisition and directly related to enhancement in value. Indexation benefit is not available.
Summary
Only capital expenses like structural renovation qualify as cost of improvement under capital gains rules. Indexation applies only to long-term assets.
Final Word
Understanding and correctly reporting the cost of improvement in capital gains can significantly reduce your tax outgo. But be cautious: not every rupee spent on a property upgrade qualifies.
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