Removal of Indexation for Homeowners: A Path to Better Investment Returns
Removal of Indexation for Homeowners: A Path to Better Investment Returns
The new tax regime encourages investors to focus on superior assets and inflation-beating returns, despite initial concerns about the removal of indexation benefits.
The recent budget has stirred up strong reactions due to the changes in capital gains taxation, particularly the removal of indexation for long-term capital gains (LTCG) on property transactions. This change has not been well-received by many taxpayers. However, ceasing to view investments primarily through the lens of indexation might lead to better investment decisions and superior returns.
The government has reduced the LTCG tax to 12.5% across multiple asset classes, including property, gold, ETFs, fund of funds (FOF), international funds and unlisted securities. Additionally, the holding period for these assets has been shortened to 24 months from the previous 36 months in some cases, for the gains to be considered long-term.
Typically, such tax reductions and broadened investment choices would be celebrated as they offer more avenues for creating long-term wealth with lower taxation. This shift allows investors to be asset-agnostic, removing tax-induced biases and enabling investment decisions based purely on merit. Consequently, the overall quality of investment portfolios can significantly improve, reducing an over-reliance on listed equities for wealth creation.
However, the removal of indexation benefits for calculating LTCG on property has caused considerable dissatisfaction. Previously, property owners could adjust the cost of their property against inflation for the entire holding period, insulating them from inflation’s impact. Now, this responsibility falls on property owners to ensure their investments beat inflation and deliver superior returns. Only then would the lower tax rate be advantageous.
While the removal of indexation may seem unfair initially, it could prove beneficial in the long term. Past experiences with investments lacking indexation benefits offer valuable lessons. In 1999, investors in listed equities could choose between an LTCG tax of 20% with indexation benefits or a straightforward 10% tax on the entire LTCG. Most opted for the simpler tax regime, leading to a significant mindset shift. Investors began focusing on making decisions that delivered inflation-beating returns rather than obsessing over tax loss harvesting.
This change occurred because the attractive tax rate encouraged better investment practices. Similarly, the new LTCG regime presents an opportunity to adopt a more objective and outcome-driven approach to home buying. Although public sentiment is currently resistant, this perspective will likely change over time.
The decision to buy or sell an asset should now be driven by asset allocation goals and the intention to enhance overall asset quality. If an investor does not wish to reinvest all gains in real estate solely to save on taxes, they can pay the lower LTCG tax and reinvest in superior assets. This strategy can significantly improve asset portfolios, delivering superior, inflation-beating returns.
A lower LTCG tax fosters capital growth and wealth creation. Investors seeking to build wealth should actively pursue long-term capital gains by leveraging superior asset options at lower tax rates. Gold, for instance, becomes a more stable and serious investment choice with the dual benefits of lower LTCG tax and a shorter holding period of two years. Multiple asset classes now offer better long-term capital gains over shorter periods at reduced tax rates.
As taxpayers begin to evaluate their reinvestment options and investment rationale more calmly, they will better understand the relative merits of reinvesting LTCG in another property versus paying taxes and moving capital to better asset choices. This shift in mindset, where taxes are no longer the sole decision driver, will become increasingly appreciated for its role in determining successful investment outcomes.
