Claim tax benefit on costs incurred to evict tenants

While computing capital gains, compensation paid to occupants for vacating the house can be deducted as money spent on improvement of property

While selling a property, if the owner pays a compensation to evict residents, can he get tax benefit on the amount paid? If one goes by different high courts’ rulings, this can be considered as a cost incurred for improvement of the property. An owner can deduct this while computing capital gains tax.

Benefits permitted

Capital gain is calculated by deducting the cost of acquisition of the asset, expenditure incurred wholly and exclusively in connection with the transfer, and cost incurred on improvement of the asset from the selling price. The three costs incurred are important for determining the capital gain on the sale of an asset and the final tax one has to pay.

Among these three, cost of acquisition includes the purchase price and any incidental expenses such as taxes and fees that seller paid on property purchase. Expenses incurred for a transfer include brokerage and legal expenses. Cost of improvement is expenses incurred in order to extend the life of an asset or increase its value. Routine expenses like repairs and maintenance of the asset, however, are not capital expenses and therefore would not be treated as cost of improvement.

Also, when computing long-term capital gains the cost of acquisition and expenses incurred on improvement are allowed to be indexed from the date of acquisition and improvement until the date of sale of the property. Indexation is a technique to adjust tax payments by employing a price index issued by the Income Tax department, which adjusts for inflation. It essentially takes into account inflation from the time an individual bought the asset to the time he sells it. It allows the asset owner to inflate the purchase price of the asset by taking into account the impact of inflation. End result: An individual gets to lower his tax liability.

Courts have favoured tenants

What constitutes cost of improvement and expenses in connection with the transfer of an asset has been disputed by the Income Tax department and assessees over the years. In their bid to reduce tax liability, assessees have claimed deductions for various types of expenses as cost of improvement or as expenses in connection with the transfer, resulting in interesting situations coming up before the judicial authorities.

One such case came up before the Bombay High Court in the case of Commissioner of Income Tax (CIT) vs  Piroja Patel. This was a case where the seller, before selling her vacant land, had paid a certain sum as compensation to evict dwellers on the land. The assessee’s contention was that the compensation paid by her to the residents qualified as cost of improvement since it contributed to the improvement in the title of the land, thereby increasing the value of the land. The High Court upheld the assessee’s contention and it allowed her to deduct the compensation paid while calculating capital gain tax on sale of the land.

The Andhra Pradesh High Court also decided a similar issue in favour of the assessee in the case of Naozar Chenoy vs CIT. The assessee had paid a certain amount to his tenants for vacating the premises before the sale and claimed a deduction for such payment as expenses in connection with the transfer of the asset. The court held that this expenditure would be allowed as a deduction as it had a direct connection with the sale. Without the tenants vacating the premises, the sale would not have been possible, the court ruled. This view was also upheld in various other judicial precedents, including the Madras High Court’s ruling in the case of CIT vs. A Venkataraman.

Compensation to family members

An interesting case (Nanubhai Keshavlal Chokshi Hindu Undivided Family) related to cost of improvement came up before the Ahmedabad Income Tax tribunal. This was a case where the assessee’s brothers were residing in the house, which was sold. Though they were not paying any rent to the assessee for occupying the premises, they had been living there for more than 24 years and had been paying the electricity bills.

When the assessee wanted to sell the house, he had to reach some settlement with his brothers. Failing this, he would have to file a suit for possession and it would have been difficult to find prospective buyers. The assessee therefore paid a certain amount to his brothers as compensation for vacating the house. He claimed a deduction for the amount paid to his brothers as cost incurred on improving the asset. The assessing officer disallowed the deduction on the ground that the assessee’s brothers were neither living in the house in the capacity of a tenant nor were they paying any rent to the assessee. This view of the assessing officer was upheld by the Commissioner (Appeals).

The taxpayer went to the tribunal, which held that the payments were made for improvement of title of the property. The assessee was hence entitled to claim a deduction on the amount paid.  

Though the courts have generally ruled in favour of the taxpayers on the issue of compensation paid to vacate the property prior to sale, before claiming such expenses as cost of improvement or expenses incurred in connection with the transfer, it is important to examine the facts of each case in detail.

Relief for property sellers

• While computing capital gains tax after selling a property, the Income-Tax Act allows owners some deductions
• One can deduct the cost of acquisition, money spent on improvements, and expenditure incurred for selling the asset from the consideration received 
• If a landlord pays a compensation to evict tenants, he can deduct this as a cost incurred for improvement of the property
• Recently, an I-T tribunal has ruled that even if the occupants are not tenants, payments made to regain the property can be deducted while computing capital gains tax

Mistry is partner, Nagarsenkar is director, and Tanna is deputy manager at Deloitte Haskins and Sells