When you inherit a flat from your father or receive shares as a gift from your uncle, you haven't paid anything out of pocket — so what's your cost of acquisition when you eventually sell? That's exactly what Section 49 answers. Without it, the cost would be ₹0 and the entire sale proceeds would be taxed as capital gain, which would be wildly unfair.
The core rule under Section 49(1) is beautifully simple: if you got the asset through a gift, will, inheritance, HUF partition, or certain tax-neutral transfers under Section 47, your cost of acquisition is whatever the previous owner originally paid for it — plus any improvement costs incurred by either them or you. The law calls this the "previous owner" rule. And if the previous owner also got it as a gift or inheritance, you trace back further until you find someone who actually bought it. That person's purchase price becomes your cost. This chain-tracing concept is what the Explanation to Section 49(1) codifies.
For amalgamations (sub-section 2): If you held shares in Company A (amalgamating company) and got shares in Company B (amalgamated company) in a tax-free merger under Section 47(vii), your cost in the new shares = your original cost in Company A's shares. Nothing changes — the tax basis just carries forward.
For sweat equity shares (sub-section 2AA): Employees sometimes receive shares as part of their compensation (sweat equity). The Fair Market Value (FMV) on the date of allotment is already taxed as a perquisite under the head "Salaries". So when you later sell these shares, your cost of acquisition = that same FMV. This prevents double taxation — you're not taxed again on what was already treated as salary income.
For exam purposes, sub-section (1) is the workhorse — it covers gifts, inheritance, and HUF partitions and is tested as a numerical almost every attempt. Sub-section (2AA) on sweat equity is a favourite theory/short-note question.
📊 Worked example
Example 1 — Inherited Property
Mr. Sharma's father purchased a residential flat in Delhi in FY 2001-02 for ₹8,00,000. He spent ₹2,00,000 on renovation in FY 2005-06. Mr. Sharma's father passed away in FY 2015-16, and Mr. Sharma inherited the flat. He sold it in FY 2025-26 for ₹95,00,000. Compute capital gain (ignore indexation for simplicity).
Working:
- Mode of acquisition = Inheritance → Section 49(1) applies
- Cost of acquisition to Mr. Sharma = Cost to previous owner (father) = ₹8,00,000
- Cost of improvement (by previous owner) = ₹2,00,000
- Total cost = ₹8,00,000 + ₹2,00,000 = ₹10,00,000
- Sale Consideration = ₹95,00,000
- Capital Gain = ₹95,00,000 − ₹10,00,000 = ₹85,00,000
(In the actual exam, you'd apply Cost Inflation Index from the year the previous owner acquired it.)
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Example 2 — Sweat Equity Shares
Ms. Iyer works at a startup and was allotted 1,000 sweat equity shares on 01-April-2023. The FMV on that date was ₹200 per share, which was taxed as a perquisite in her salary. She sells all 1,000 shares in January 2026 for ₹350 per share.
Working:
- Cost of acquisition per Section 49(2AA) = FMV already taxed as perquisite = ₹200 per share
- Total cost = 1,000 × ₹200 = ₹2,00,000
- Sale proceeds = 1,000 × ₹350 = ₹3,50,000
- Capital Gain = ₹3,50,000 − ₹2,00,000 = ₹1,50,000 (Short-term, held < 24 months)
Note: If cost were taken as ₹0, the entire ₹3,50,000 would be taxed — a clear case of double taxation that Section 49(2AA) prevents.
⚠️ Common exam mistakes
- Students take cost as ₹0 for gifted/inherited assets. Wrong — Section 49(1) says cost = what the previous owner paid. Always trace back to the person who actually purchased the asset.
- Forgetting to include improvement costs. The formula is previous owner's purchase price PLUS improvement costs by both previous owner and current assessee. Students often drop improvements made by the previous owner.
- Getting the indexation base year wrong for inherited property. You apply the Cost Inflation Index from the year the previous owner acquired it (or FY 2001-02, whichever is later), NOT from the year you inherited it. This is a very common 1-mark slip.
- Confusing Section 49(2AA) with Section 49(2A). Section 49(2AA) is for sweat equity/specified securities taxed as perquisite under salary (Sec 17(2)(vi)) — cost = FMV at allotment. Section 49(2A) is for conversion of debentures/bonds to shares — cost = proportionate cost of the original debenture. Don't mix them up.
- Applying Section 49 to assets received on dissolution of a firm after 01-April-1987. Section 49(1)(iii)(b) only covers dissolutions before 01-April-1987. For later dissolutions, different rules apply. If an exam fact pattern gives a post-1987 firm dissolution, watch out — Section 49(1) won't apply.
📖 Bare Act text — Section 49, Income Tax Act 1961
(click to expand)
(1) Where the capital asset became the property of the assessee—
(i) on any distribution of assets on the total or partial partition of a Hindu undivided family;
(ii) under a gift or will;
(iii) (a) by succession, inheritance or devolution, or
(b) on any distribution of assets on the dissolution of a firm, body of individuals, or other association of persons, where such dissolution had taken place at any time before the 1st day of April, 1987, or
(c) on any distribution of assets on the liquidation of a company, or
(d) under a transfer to a revocable or an irrevocable trust, or
(e) under any such transfer as is referred to in clause (iv) or clause (v) or clause (vi) or clause (via) or clause (viaa) or clause (viab) or clause (vib) or clause (vic) or clause (vica) or clause (vicb) or clause (vicc) or clause (xiii) or clause (xiiib) or clause (xiv) of section 47;
(iv) such assessee being a Hindu undivided family, by the mode referred to in sub-section (2) of section 64 at any time after the 31st day of December, 1969, the cost of acquisition of the asset shall be deemed to be the cost for which the previous owner of the property acquired it, as increased by the cost of any improvement of the assets incurred or borne by the previous owner or the assessee, as the case may be.
Explanation.—In this sub-section the expression "previous owner of the property" in relation to any capital asset owned by an assessee means the last previous owner of the capital asset who acquired it by a mode of acquisition other than that referred to in clause (i) or clause (ii) or clause (iii) or clause (iv) of this sub-section.
(2) Where the capital asset being a share or shares in an amalgamated company which is an Indian company became the property of the assessee in consideration of a transfer referred to in clause (vii) of section 47, the cost of acquisition of the asset shall be deemed to be the cost of acquisition to him of the share or shares in the amalgamating company.
(2A) Where the capital asset, being a share or debenture of a company, became the property of the assessee in consideration of a transfer referred to in clause (x) or clause (xa) of section 47, the cost of acquisition of the asset to the assessee shall be deemed to be that part of the cost of debenture, debenture-stock, bond or deposit certificate in relation to which such asset is acquired by the assessee.
(2AA) Where the capital gain arises from the transfer of specified security or sweat equity shares referred to in sub-clause (vi) of clause (2) of section 17, the cost of acquisition of such security or shares shall be the fair market value which has been taken into account for the purposes of the said sub-clause.
(2AAA) Where the capital asset, being rights of a partner referred to in section 42 of the Limited Liability Partnership Act, 2008 (6 of 2009), became the property of the assessee on conversion as referred to in clause (xiiib) of section 47, the cost of acquisition of the asset shall be deemed to be the cost of acquisition to him of the share or shares in the company immediately before its conversion.
(2AB) Where the capital gain arises from the transfer of specified security or sweat equity shares, the cost of acquisition of such security or shares shall be the fair market value which has been taken into account while computing the value of fringe benefits under clause (ba) of sub-section (1) of section 115WC.
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