Section 55 of the Income-tax Act: Cost of Acquisition and Cost of Improvement
Section 55 explains how certain capital assets are valued for calculating capital gains, including the acquisition cost of inherited assets, the treatment of improvements, intangible rights, bonus shares and the grandfathering rule for specified investments.
Overview of Section 55
Capital gains generally depend on the consideration received from transferring a capital asset, allowable transfer expenses, and its recognised cost of acquisition and improvement. Section 55 provides special definitions for the purposes of Sections 48 and 49. The word "adjusted" remains in the historical heading although the former definition in Section 55(1)(a) was omitted.
Section 48 deals with the method of computing capital gains, while Section 49 specifies the cost for assets acquired through certain modes, including gifts, inheritance and specified reorganisations. Section 55 determines how particular costs are measured under those provisions.
Cost of improvement under Section 55(1)(b)
Cost of improvement means qualifying capital expenditure incurred to make additions or alterations to an asset. For assets acquired before 1 April 2001, the relevant expenditure is generally expenditure incurred on or after that date by the assessee or previous owner. For assets acquired subsequently, qualifying expenditure incurred after acquisition is considered, including qualifying expenditure of a previous owner in cases covered by Section 49(1).
Expenditure already deductible while computing income under another applicable head cannot be claimed again as cost of improvement. Routine repairs and maintenance are not automatically capital improvements; their nature and tax treatment must be examined.
Intangible assets and rights
Under the special rule, the cost of improvement is treated as nil for goodwill or other intangible assets of a business and specified manufacturing, business or professional rights and other rights covered by the statutory wording. This rule prevents attributing an unsupported improvement cost to such assets.
Cost of acquisition under Section 55(2)
Cost of acquisition is the amount recognised by law as the capital cost of obtaining an asset. It may differ from the price paid where a special statutory deeming rule applies.
Goodwill, trademarks, tenancy rights and other intangible rights
Section 55(2)(a) addresses goodwill of a business or profession, trademarks or brand names, other intangible assets, rights to manufacture or conduct business or a profession, tenancy rights, stage carriage permits, loom hours and other covered rights. Where purchased from a previous owner, the recognised cost is generally the purchase price. In specified other cases, including self-generated assets, the deemed cost is nil, subject to Section 49 and the precise statutory exceptions.
Stock exchange demutualisation
For equity shares allotted to a member under a SEBI-approved corporatisation or demutualisation scheme, Section 55(2)(ab) generally carries forward the cost of original stock exchange membership to those shares. The cost of associated trading or clearing rights is deemed nil.
Rights issues and bonus shares: Section 55(2)(aa)
| Asset or transaction | General acquisition cost rule |
|---|---|
| Original shares or securities | Amount actually paid for acquiring the original holding. |
| Right to subscribe, renounced by holder | Nil cost to the person renouncing the entitlement. |
| Rights shares subscribed for | Amount actually paid to acquire those shares. |
| Bonus shares allotted without payment | Generally nil under the specific rule, subject to other applicable provisions. |
| Rights entitlement purchased from another person | Amount paid for the entitlement plus the subscription price paid to the issuer. |
These rules apply to the types of financial assets described in the provision. Corporate actions, grandfathering and other special provisions may affect the final tax computation.
Grandfathering of investments under Section 55(2)(ac)
For eligible long-term equity shares, equity-oriented fund units and business trust units referred to in Section 112A and acquired before 1 February 2018, the deemed cost is the higher of the actual acquisition cost and the lower of the fair market value as at 31 January 2018 and the sale consideration.
For listed securities, the fair market value normally uses the highest quoted price on 31 January 2018 or, where not traded that day, the applicable immediately preceding trading date. For unlisted units, the relevant net asset value is used. Special valuation rules apply to certain shares unlisted on that date but listed when transferred.
The grandfathering rule fixes the recognised cost; it does not by itself determine the applicable capital gains tax rate, exemption threshold or holding-period test.
Assets acquired before 1 April 2001: Section 55(2)(b)
For qualifying assets acquired before 1 April 2001, the assessee can generally choose the actual acquisition cost or the fair market value as on 1 April 2001. Similar treatment may be available for assets received under Section 49(1) where the previous owner acquired the asset before that date.
For land or buildings, the fair market value adopted as on 1 April 2001 cannot exceed the stamp duty value as on that date, where available. Proper valuation evidence is important. Section 55 also provides specific rules for assets received on liquidation, share consolidations, subdivisions and conversions, and for cases in which a previous owner's cost cannot be determined.
Where the previous owner's cost is unknown
Under Section 55(3), where the previous owner's acquisition cost cannot be ascertained, it is deemed to be the fair market value on the date on which the asset became the previous owner's property.
Indexation after 23 July 2024
Indexation is generally unavailable for long-term capital assets transferred on or after 23 July 2024. A specific protective comparison applies for eligible resident individuals and Hindu undivided families transferring land or buildings acquired before that date: tax calculated under the new regime is capped by the tax computed under the earlier 20% indexed method, where the statutory conditions are met. This is a tax-liability comparison, not an unrestricted option to index all assets.
Practical examples of cost computation
Example 1: Property purchased before 2001
A property purchased in 1995 for Rs. 4 lakh has an eligible fair market value of Rs. 12 lakh on 1 April 2001. Subject to the applicable stamp duty value ceiling and evidence, the taxpayer may use Rs. 12 lakh as the acquisition cost under Section 55. Any separately qualifying post-2001 improvements are considered under the applicable rules.
Example 2: Bonus shares
An investor receives 100 bonus shares without paying consideration. The statutory cost of those bonus shares is ordinarily nil; the original shares retain their own cost, subject to any special rule applicable to the holding.
Example 3: Section 112A grandfathering
Suppose an eligible share cost Rs. 100, its qualifying fair market value on 31 January 2018 was Rs. 180 and it was sold for Rs. 160. The deemed acquisition cost is Rs. 160: higher of Rs. 100 and the lower of Rs. 180 and Rs. 160. This illustration addresses only the acquisition cost, not the entire tax liability.
Official legislation and related provisions
- Income-tax Act, 1961, as amended by Finance Act, 2025 (official PDF)
- Section 55: official provision (2025 edition)
- Income-tax Act, 2025 (official text)
- Income Tax Department: capital gains guidance
- Section 55: historical amendments (2023 edition)
Historical amendment notes in older versions include the change in the valuation base date from 1 April 1981 to 1 April 2001, the introduction of Section 55(2)(ac) in 2018, and later changes concerning goodwill and intangible assets. For a transaction, consult the statute applicable to the relevant tax year and any transitional provisions.