Inheritance Tax - Meaning, Calculation and Applicability

Inheritance tax is a levy imposed on individuals who inherit money, property, or other assets from a deceased person. Inherited assets can be received through a will, succession, nomination, or joint ownership. While India abolished inheritance tax in 1985, certain tax obligations still apply, such as income tax on earnings from inherited assets and capital gains tax on their sale. Additionally, special tax rules exist for inherited mutual funds and assets owned by NRIs. This article provides a comprehensive overview of inheritance taxation, its calculation, and its applicability in various scenarios.

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What is an Inheritance Tax?

Inheritance tax is a tax imposed on individuals who inherit money, property, or other assets from a deceased person. It applies to various inherited assets, including ancestral property, mutual funds, gold, and other movable or immovable items, whether received through a Will or by succession. The tax liability falls on the beneficiary rather than the estate itself, distinguishing it from estate tax. Inheritance taxation laws and rates vary across countries, making it essential for heirs to understand their tax obligations when acquiring inherited wealth.

Inheritance Tax in india - A Brief Overview

Inheritance tax, known as estate duty, was once applicable in India when assets were transferred to heirs upon a person's death. However, it was abolished in 1985. Earlier, under the Estate Duty Act of 1953, estates valued over Rs. 20 lakh were subject to an estate duty of 85%. Despite this high rate, the tax faced heavy litigation, and its revenue generation was minimal—amounting to just Rs. 20 crore in 1984-85, which was only 0.4% of the total direct tax collection. Due to its complexity and high administrative costs, the government discontinued estate duty in March 1985.

While India does not impose an inheritance and taxes today, certain tax liabilities still apply. If inherited assets generate income, such as rent or interest, it must be declared in the income tax return and is subject to taxation. Additionally, if heirs sell inherited assets, they is an applicability of capital gains tax on inherited property for the profit earned from the sale. By understanding the inheritance tax applicability in India, one can undertake inheritance tax planning.

Types of Inheritance Tax in India

In India, there is no inheritance taxation levied when you inherit property or other assets. However, it is essential to declare the inherited property while filing your annual tax return. Inherited assets can be received through various means, such as a will, nomination, or joint ownership. Let’s explore the different types of inheritance in India:

1. Will of Succession

A will of succession occurs when an individual creates a will and names legal heirs who will inherit their property and assets after their death. The will must be prepared and signed by the testator (the person making the will). The rules governing succession in India are outlined in the Indian Succession Act, ensuring that the wishes of the deceased are honoured.

2. Inheritance by Nomination

Inheritance by nomination happens when a person names a nominee for assets such as bank accounts, mutual funds, insurance policies, or shares. The nominee is not granted absolute ownership but can claim the assets after the nominee's death. This form of inheritance has gained more significance in recent years due to its growing legal recognition.

3. Inheritance by Joint Ownership

In inheritance by joint ownership, multiple individuals, often family members, become joint owners of a property or asset. The legal framework for inheritance tax on property governing joint ownership varies depending on the type of asset, such as real estate, bank accounts, or investments. When one joint owner passes away, the remaining joint holders automatically inherit the deceased person’s share.

Additionally, there are three specific types of joint ownership:

• Tenants in Common: This involves multiple people purchasing a property without specifying ownership shares. If one person dies, their share passes to their legal heir rather than the surviving joint owners.
• Joint Tenancy: In this case, all joint owners have equal shares and interest in the property. When one of the joint tenants dies, the surviving tenants inherit the deceased's share.
• Tenancy by Entirety: Typically, this ownership is between spouses, where neither can sell the property without the other's consent. Ownership only ends through death, divorce, or mutual agreement between the spouses.

How is the Inheritance Taxion Calculated?

The calculation of inheritance and taxes depends on the jurisdiction you reside in. In India, there is no inheritance tax on property or others, but other countries may impose taxes on inherited properties or assets.

Here’s a general approach to calculating inheritance tax:

Step 1: Determine the Gross Value of the Inherited Assets

First, calculate the total market value of the deceased’s assets you’ve inherited. This includes investments, real estate, vehicles, and personal belongings.

Step 2: Deduct Any Debts or Liabilities

If the estate has any outstanding debts or liabilities, subtract these from the gross value of the inherited assets.

Step 3: Apply Exclusions or Exemptions

Check if any exclusions or exemptions apply to the inherited assets. If applicable, subtract these from the estate’s taxable value.

Step 4: Calculate the Taxable Value

After deducting debts, liabilities, and applicable exemptions, determine the remaining taxable value of the inherited estate.

Step 5: Calculate the Inheritance Tax

Finally, apply the  inheritance and taxes rate based on the location or country to the taxable value to calculate the total tax payable on the inherited assets.

Taxation on Inherited Assets in India

Though India does not impose an inheritance tax, inheritors must be aware of certain tax implications associated with inherited assets. Let’s explore the key aspects:

Income Tax Implications on Inherited Property

Inheriting a property does not attract any income tax. However, if the inherited asset generates income—such as rental income from a property—the legal heir must declare it while filing income tax returns. Taxes are applicable as per the individual’s income tax slab.

Also read: How to file an income tax returns for a deceased person?

Capital Gains Tax on Inherited Property

If you decide to sell an inherited property, capital gains tax applies based on the holding period:

• Short-term Capital Gains (STCG): If sold within two years of inheritance, the profit is taxed as per the applicable income tax slab.
• Long-term Capital Gains (LTCG): If held for more than two years, LTCG tax is levied at 20% after applying indexation benefits.

It is advisable to consult a tax professional before selling an inherited asset to understand the applicable tax liabilities.

Tax on Inheritance of Immovable Property

No tax is levied at the time of inheriting immovable property. However:

• Capital gains tax is applicable if the property is later sold.
• Property tax must be paid annually by the new owner.
• Rental income tax applies if the property is rented out, and must be declared in tax filings.

Tax on Inheritance of Movable Assets

Movable assets such as bank accounts, lockers, and vehicles do not attract inheritance and taxes . However, certain formalities must be completed:

• Bank accounts: The legal heir must update the account holder’s status but does not incur any tax liability.
• Lockers: Contents are transferred to the heir without any tax implications.
• Vehicles: The ownership must be transferred at the respective RTO, but no tax is levied on inheritance.

Tax on Subsequent Sale of Inherited Assets

Upon inheriting an asset, the new owner is free to retain or sell it. While ownership transfer itself does not attract tax, selling the asset leads to capital gains tax liability as discussed earlier. Additionally, if the asset generates income—such as rental income from property—it must be reported in annual tax filings.

Taxation on Inherited Mutual Funds in India

In India, inherited mutual funds are not subject to any direct taxation under the Income Tax Act of 1961. As a legal heir, you do not have to pay taxes simply for inheriting mutual funds or other movable assets like shares and gold. However, if you choose to redeem or sell the inherited mutual funds, capital gains tax will apply. The tax rate depends on the holding period, with short-term capital gains (STCG) taxed as per your income tax slab and long-term capital gains (LTCG) taxed as per the prescribed rule. 

Learn more: Income tax on Mutual Funds

NRI Selling Inherited Property in India Tax Implications

NRIs selling inherited property in India are required to pay capital gains tax based on the holding period. Since inheritance does not create an immediate tax liability, the classification of capital gains depends on when the original owner acquired the property. If the property is sold after more than two years, the gains are considered long-term capital gains (LTCG). However, if sold within two years of acquisition, the gains are classified as short-term capital gains (STCG), and the tax treatment varies accordingly.

Conclusion

In conclusion, while India does not impose an inheritance tax, inheritors must be mindful of associated tax liabilities, such as income tax on earnings from inherited assets and capital gains tax on their sales. Understanding the tax implications of inherited property, mutual funds, and other assets is crucial for effective financial planning. NRIs selling inherited assets in India should also be aware of applicable capital gains tax rules. Consulting an IndiaFilings tax professional can help ensure compliance with relevant inheritance taxation laws and optimise financial decisions regarding inherited wealth.

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FAQ

1. What is the difference between inheritance tax and estate tax?

Inheritance tax is paid by the beneficiary upon receiving inherited assets, whereas estate tax is levied on the total estate of the deceased before distribution to heirs.

2. Does India have an inheritance tax?

No, India abolished inheritance tax, known as estate duty, in 1985. However, taxes like capital gains tax and income tax may apply to inherited assets.

3. Are inherited assets taxable in India?

Inheriting assets does not attract tax, but income generated from them (such as rent or interest) and capital gains on their sale are taxable.

4. How is the implications for inheritance tax on property?

If sold within two years, short-term capital gains tax applies per the individual’s tax slab. If sold after two years, long-term capital gains tax at 20% applies with indexation benefits.

5. Do NRIs have to pay tax on inherited property in India?

NRIs do not pay tax on inheritance, but if they sell the property, capital gains tax applies based on the original owner's purchase date.

6. Is there an inheritance taxation on inherited mutual funds in India?

No tax is levied on inheriting mutual funds, but capital gains tax on inherited property applies if they are redeemed or sold.

7. How is inheritance handled through nomination in India?

Nominees can claim assets such as bank accounts, mutual funds, or insurance, but legal heirs may have ownership rights as per succession laws.

8. What happens if inherited property generates rental income?

The legal heir must declare the rental income in their income tax return and pay tax as per their applicable slab rate.

9. Are bank accounts and lockers taxable when inherited?

No, inherited bank accounts and locker contents do not attract inheritance and taxes, but heirs must update ownership details.

10. Do spouses automatically inherit property in India?

If property is jointly owned under tenancy by entirety, the surviving spouse inherits it. Otherwise, inheritance depends on succession laws and the presence of a valid will.

11. Why is inheritance tax planning important?

Inheritance tax planning helps reduce the tax burden on beneficiaries by structuring asset transfers efficiently. Proper planning ensures compliance with tax laws while maximizing exemptions and reliefs.