What is Tax on Inheritance and its Implications?

What is Tax on inheritance?

Inheritance tax, also known as estate tax or death tax, is a levy imposed on the property of assets of the deceased person. It is assessed and collected from the estate before the estate distribution to the beneficiaries named in the will or according to the intestate succession laws.

In many countries, the beneficiary or the heir is responsible for paying the inheritance tax for inheriting any property or asset that belonged to their parents, grandparents, friends, and other relatives. For example, in countries like the United Kingdom, the United States of America, Australia and Germany, there are certain tax codes in relation with the inheritance tax that the citizens must follow. In India since 1985, taxpayers don't have to worry about inheritance tax as the same have been abolished.

 

How was Inheritance Tax Calculated?

Here are the steps to calculate inheritance taxation –

1. Find out the aggregate market value of the assets owned by the deceased when they passed away.
2. Assets include every investment, personal belonging, and property that the deceased owned, like jewellery, real estate, investment plans, bank balances, etc.
3. Subtract the liabilities from the value of the assets to get the estate’s net value.
4. Apply the applicable inheritance tax rates on inheritance.
5. In certain instances, some portion of the estate might enjoy tax exemption or allowances. In other instances, progressive tax rates might apply. Know these facts when calculating the tax liability on inheritance.
6. You can use tax-saving strategies like gifting or setting up a trust to reduce your tax liability on inheritance.
    

Tax and Legal Implications on Inheritance

In the event of the death of a person, properties or assets belonging to them will be passed down to their legal heirs. Since this transfer is made without any consideration in return, the properties or assets will qualify as ‘gifts’ for income tax. The Income Tax Act, of 1961 specifically excludes assets received through inheritance or under a will from the purview of the gift tax. Accordingly, the tax law does not allow any taxes to be levied on properties received in the form of inheritance.

 

Tax Implications on Subsequent Sale

After you inherit a property, you become its legal owner. As an owner, you have the right to sell the property if needed. Any capital gains or losses incurred on the sale would accrue to you. The tax implications of any capital gain earned from the sale of inherited property would depend on the holding period. This holding period includes the holding period by the deceased and by you.¹

For instance, say Mr Verma inherits shares worth ₹10 lakhs from his father. His father bought the shares on 1^st January 2020, and Mr Verma inherited them on ₹1^st May 2024. Mr Verma sells the shares on 1^st August 2025 for ₹15 lakhs. Since he and his father held the shares for more than 12 months, the capital gain of ₹5 lakhs would be treated as long-term capital gain. Tax benefits would be available on gains up to ₹1.25 lakhs, which would be tax-free, and the excess would be taxed at 12.5%.

 

Tax on Income from Inheritance

Sometimes, the inherited property can be a source of income for the owner. This income could be in the form of rent, interest etc. When the heir receives the inheritance, they become the owner of the property, and if the heir has a source of income through this property then tax will be applicable on the income generated. So if the inheritance generates income, you are required to declare the income and pay taxes accordingly as the new owner.

 

Tax on Movable Assets

Moveable property includes bank deposits, life insurance policies, stocks and securities, post office schemes, mutual funds, provident funds, jewellery etc. Here are some things to know -

• A valid will is a key factor when it comes to determining the distribution of these, especially financial properties.
• When an individual dies without making a will, inheritance is primarily based on the laws of inheritance in place for the individual on the grounds of their religion.
  
  For example, the Hindu Succession Act will come into play to determine the distribution of assets when a Hindu person passes away without leaving a will. The Act has clearly defined who the Class 1 and Class 2 heirs are. As per Muslim law, while an individual is allowed to distribute one-third of their assets through a will, the rest is inherited based on their religious laws.

• For the transfer of inheritance, the documents required include the death certificate of the deceased individual and a court order (in case no will exists).
• When there is a valid will, you need to present a copy of the probate which determines that a court has verified and certified the authenticity of the will.
• Since Indian income-tax law states that dividends are tax-free, inheritance of assets such as shares or mutual funds is tax-free.
• However, when these assets including mutual funds, shares or even a major stake lead to a generation of income or gains, taxes are to be paid accordingly.
   

Tax on Immovable Assets

Properties such as land, buildings, structures, warehouses, factories etc. come under immovable assets. Since there is no inheritance tax law in India, no tax will be applicable on inheritance of a property. However, tax will be levied in case it generates any capital gains. For example, if you plan to sell an inherited property, you will have to pay the capital gains tax.

To determine the amount of gains, you can deduct the expenditure/cost incurred at the time of purchasing the property and any cost incurred while selling it. In case the property was bought before April 1, 1981, you can either consider the original purchase cost or the market value on April 1, 1981. If it was purchased only three years before, availing of indexation benefits will help you in reducing tax on capital gains of the property.

When assessing whether the assets fall under long-term or short-term gains, you need to factor in the holding period of the “gift giver” or the previous owner as well.

When you have inherited a property in which you reside and have only one house to your name, then income tax will not be levied as it will be considered as self-occupied property. However, in case you have two or more properties, the second one will be deemed let out and rental income will be applied to them.

So, while you are not required to pay taxes upon the inheritance of an asset (movable or immovable), any income or capital gains generated on that asset will be subject to tax.

 

Key Takeaways

1. Inheritance tax is applicable to the property of a deceased individual. The tax is collected from the deceased’s estate before the estate is distributed.
2. To calculate the inheritance tax, you need to find the estate’s current market value as of the owner’s date of death, subtract the liabilities and apply the applicable tax rates.
3. If the inherited assets are sold, you might incur a capital gain, which would be subject to a capital gains tax depending on the asset’s total holding period.
4. If you earn interest or any other income from a property, such income would also be taxed in your hands.
    

Conclusion

Currently, inheritance tax is not applicable in India. However, it is prudent to understand what this tax is all about and how it is applicable on inherited property and income. While inheriting property does not incur any tax, any capital gains arising on subsequent sale or any income earned from an inherited property might be taxable. So, understand the provisions of inheritance tax for better clarity.

 

FAQs

1. Is there any tax on Inheritance in India?

   While there is no tax on inheritance in India, taxes will be applied to any income generated on that inheritance.

   
   

2. Can NRIs inherit property in India?

   Yes, NRIs can inherit property or assets in India. According to the Foreign Exchange Management Act (FEMA), NRIs are also generally exempt from inheritance tax.

   
   

3. Do inherited shares attract capital gains tax?

   Inherited shares do not attract capital gains tax unless they are sold. If you sell the inherited shares, then there would be a capital gains tax depending on the holding period after which the sale took place.²

   
   

4. Is inheritance tax-free in India?

   Yes, currently there’s no inheritance tax on inherited assets in India.¹
    

Sources:

1. https://cleartax.in/s/inheritance-tax
2. https://cleartax.in/s/capital-gains-gifted-assets