The joint family property under Hindu law is a common financial and estate-planning strategy for converting a self-owned property into a joint family property. But when converting to the Income Tax Act, 1961, there are tax implications specific to the conversion. Knowledge of the regulation of such transfers, their classification, and the effects under Indian taxation rules is essential for the proper and efficient management of wealth.
Conversion into HUF Property
Hindu Undivided Family (HUF) is an independent taxable personhood under Indian law. It is a group of individuals who are lineally descended from a common ancestor, wives and daughters who are not married. The term ‘throwing into the typical hotchpot/blending’ refers to a situation in which a person voluntarily donates his self-acquired property to the shared pool of HUF property.
When this has been done, the property becomes the community property and loses its individuality. Nonetheless, this transfer is special, although it is not only willful, but is legally binding, and it is not subjected to taxation in the same way as standard transfers of property, as that of the Income Tax Act, 1961.
Income Tax Law: Whether Conversion is Treated as a Transfer?
Section 2(47) of the Income Tax Act defines a transfer as generally being the sale, exchange or parting of an asset. Section 64(2), however, covers the cases when a person transfers self-obtained property into HUF property. Under this section, such a conversion is not regarded as a transfer when it comes to capital gains tax.
This implies that at the time one siphons his self-gained property into the common HUF pool, no tax is paid immediately. The conversion does not lead to the triggering of any capital gains tax because the conversion is not considered a transfer, but a notional transfer, which is not a sale or an exchange.
The reasoning is easy: the ownership is transferred to collective family ownership, without money. Nevertheless, this exemption does not exempt the individual from the future tax liability on the income from the property.
Income Taxation on Converted Property
Even though the property is transferred into the HUF, its income remains subject to taxation in the hands of the person who transferred it to the HUF. This is the most vital provision of Section 64(2).
The individual will not tax the earnings of the converted property in his or her hands but rather will combine it with personal earnings in the event that the converted property produces rental income or capital gains. This rule is meant to avoid tax evasion where one may otherwise divert income to an HUF (which may be subject to a lower tax rate).
The income can only stop being clubbed with the income of the transferor when the property is completely partitioned among members of the HUF or sold, and the proceeds are shared.
Treatment of Self-Occupied Property after Conversion
If the property was occupied by the individual and converted to the HUF, the annual value is zero, provided the HUF continues to use it as a residential property.
The situation, however, differs when the converted property is let out. Where that is the case, rental income on the property will still be taxed in the hands of the person in accordance with the clubbing rules until the time when the HUF disposes of the property or divides the property.
Accordingly, ownership is transferred to the HUF, retaining the tax liability on income with the transferor, except in the event of a sale or partition.
Capital Gain on Future Sale of Property by HUF
The capital gains will be taxable in the hands of the HUF when the HUF finally sells the property. The original cost of computing capital gains will be the cost at which an individual will purchase it.
Also, the indexation benefit (adjustment of purchase cost because of inflation) under Section 48 will be received, not excluding the conversion year, but of the year in which the individual initially acquired the property.
To illustrate, when a person bought a property in 2010 and changed it into HUF property in 2020, the HUF will be able to calculate the capital gains by applying the indexed cost in 2010.
This method makes sure that the program of the tax system considers the continuity of ownership and prevents the tax system from reevaluating and taxing the same item twice or re-establishing the artificially revalued value at the conversion point.
Practical and Documentation Considerations
Prior to turning property that they obtained on their own into the HUF property, individuals are supposed to:
- Be clear with an intent, which is made in the form of a declaration or affidavit, that the property is being blended into the assets of the HUF.
- Keep adequate records, such as a mutation record in land or municipal records, to indicate ownership under the name of HUF.
- Make sure that Section 64(2) clubbing requirements have been met with regard to taxation.
- Never transfer property that has an outstanding loan or encumbrance, as the transfer to the new owner will be considered as an infringement of the mortgage terms by the financial institutions.
- Remember that, after conversion, the property would not be allowed to be used in individual tax exemptions under Section 24 or 80C unless it is specifically identified as HUF property.
Conclusion
Transforming a self-occupied property to a HUF property is a tax-sensitive but legal act. No capital gains tax is due when the conversion takes place, but income derived during such property is liable to taxation in the hands of the transferor as per Section 64(2). Another aspect that warrants careful consideration is ownership and future sale implications.
Consequently, the conversion must be planned strategically by taxpayers so that it does not conflict with their long-term financial, family, and tax goals, which must be supported by appropriate legal documentation and compliance with the provisions of the Income Tax Act, 1961.
This is a moderate solution that guarantees compliance and the highest tax efficiency, while at the same time preserving family wealth within a well-known, time-tested framework—the Hindu Undivided Family.
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