The cost of acquisition of a capital asset is determined as per Section 55 of the Income Tax Act, 1961. It varies depending on whether the asset was purchased, inherited, gifted, or acquired before a specific date.

Section 55(2) – Cost of Acquisition of a Capital Asset:
“For the purposes of sections 48 and 49,—
(a) in relation to any capital asset,—
(i) where the capital asset became the property of the assessee before 1st day of April, 2001, the cost of acquisition shall be either—
(A) the actual cost of acquisition of the asset; or
(B) the fair market value (FMV) of the asset as on 1st April, 2001,
whichever is higher.”

Explanation in Simple Terms:

1. If You Purchased the Asset:

   • The cost of acquisition is the actual purchase price paid, including any registration fees, brokerage, or legal expenses.

2. If the Asset was Inherited or Gifted:

   • The original cost of acquisition of the previous owner is considered.

   • The holding period of the previous owner is also taken into account to determine whether the gain is short-term or long-term.

3. If the Asset was Acquired before 1st April 2001:

   • The taxpayer has an option to take either the actual purchase price or the Fair Market Value (FMV) as of 1st April 2001, whichever is higher.

4. For Assets Declared under the Income Declaration Scheme, 2016:

   • The cost of acquisition is deemed to be the FMV as of 1st June 2016 (as per Section 49(5)).

5. Indexed Cost of Acquisition (Applicable to Long-Term Capital Assets):

   • If the asset qualifies for indexation benefit (available for immovable property, unlisted shares, debt funds, etc.), the cost is adjusted for inflation using the Cost Inflation Index (CII).

   • Formula:

     Indexed Cost of Acquisition=Original Cost×CII of Year of SaleCII of Year of Purchase\text{Indexed Cost of Acquisition} = \frac{\text{Original Cost} \times \text{CII of Year of Sale}}{\text{CII of Year of Purchase}}Indexed Cost of Acquisition=CII of Year of PurchaseOriginal Cost×CII of Year of Sale​

Practical Example:

• Suppose you bought a house in 1995 for ₹10 lakhs, and you are selling it in 2025.

• Instead of ₹10 lakhs, you can take the FMV as of 1st April 2001 (say ₹25 lakhs).

• If the CII for 2001-02 was 100 and the CII for 2025-26 is 400, then:

  Indexed Cost=₹25,00,000×400100=₹1crore\text{Indexed Cost} = \frac{₹25,00,000 \times 400}{100} = ₹1 croreIndexed Cost=100₹25,00,000×400​=₹1crore

• If the house is sold for ₹1.5 crore, then:

  Capital Gain=Sale Price−Indexed Cost=₹1.5crore−₹1crore=₹50lakhs.\text{Capital Gain} = \text{Sale Price} – \text{Indexed Cost} = ₹1.5 crore – ₹1 crore = ₹50 lakhs.Capital Gain=Sale Price−Indexed Cost=₹1.5crore−₹1crore=₹50lakhs.

• Tax at 12.5% (as per Budget 2025 changes) would be ₹6.25 lakhs.

This method ensures fair tax computation by adjusting for inflation over the years.