s.45(2) — Capital gains on conversion of a capital asset into stock in trade
Where an owner converts a capital asset such as land into stock in trade of his business, the capital gain is measured at fair market value on conversion but taxed only in the year the stock is sold or otherwise transferred.
The text was read on the Department's site in the Year 2025 edition and the first Year 2019 edition of the 1961 Act, neither of which carries an amendment footnote on the sub-section. The counterpart in the Income-tax Act, 2025 is section 67(6), which charges the gain in the tax year in which the stock in trade is sold or otherwise transferred.
Income-tax Act, 1961
s.45(2)
Income-tax Act, 2025
s.67(6)
In force from 1 April 2026, but s.536(2)(c) preserves the 1961 Act for tax years beginning before that date.
In short
Section 45(2) of the Income-tax Act, 1961 provides that, notwithstanding section 45(1), the profits or gains arising from the transfer by way of conversion by the owner of a capital asset into, or its treatment by him as, stock in trade of a business carried on by him are chargeable as his income of the previous year in which that stock in trade is sold or otherwise transferred by him, and that for section 48 the fair market value of the asset on the date of conversion or treatment is deemed to be the full value of the consideration. The conversion is itself a transfer under section 2(47)(iv); the sub-section only postpones the charge. Two incomes follow from one asset: a capital gain equal to the fair market value on conversion less the cost, and a business profit equal to what the stock later fetches less that fair market value, both charged in the year of sale or other transfer. For a landowner the consequence is sharp. Land converted before a joint development agreement is no longer a capital asset when the agreement is signed, so section 45(5A), which needs a capital asset being land or building or both, cannot apply even to an individual or a Hindu undivided family; the Pune Tribunal, remanding Rakesh Motilal Sharma (June 2026), observed as much of land admittedly held as stock (para 10). In L.K. Trust (Bangalore Tribunal, June 2026) a private family trust that bought land on Palace Road, Bangalore in 1989 for Rs 1.5 crore, converted it to stock on 2 April 2009 and signed a joint development agreement in July 2010 offered, for assessment year 2018-19, after the April 2017 occupancy certificate, both a conversion gain of Rs 32,02,99,200 on the 45 per cent of the land that went to the developer and business income of Rs 14,56,40,800, and the Tribunal accepted that split; the year was not in dispute, and the appeal turned on valuation. The Pune Tribunal in Vilas Babanrao Rukari (HUF) (May 2018) held that the sums received under a revenue-sharing agreement before the project was completed were advances and that both the business profit and the section 45(2) gain were chargeable when the project was completed and the flats were handed over to buyers (para 20). The counterpart in the Income-tax Act, 2025 is section 67(6), with the fair market value on conversion deemed to be the full value of consideration for section 72.
What the provision does
Splits the gain on a capital asset that its owner turns into business stock: appreciation up to conversion is a capital gain measured at fair market value on that date, and appreciation after it is business profit, both taxed when the stock is sold or otherwise transferred. It does not say whether a joint development agreement is that later transfer, and a converted asset cannot come back within section 45(5A).
Threshold questions
- Was the asset a capital asset in the owner's hands before conversion, rather than stock in trade from the day it was acquired
- Did the owner in fact convert it into, or treat it as, stock in trade of a business he carries on, as his books and conduct show
- What was the fair market value on the date of conversion, and is it supported by a registered valuer's report
- In which year was the stock sold or otherwise transferred: the joint development agreement, the conveyance of the developer's share, or the sale of the flats
- Did the conversion take place before 23 July 2024, which bears on indexation and the rate on the capital gain
- Is the owner an individual or Hindu undivided family who gives up section 45(5A) by converting before the agreement
In practice
The recurring disputes.
Whether the joint development agreement is the sale or other transfer of the stock
The Revenue's argument is that once the land is stock, a joint development agreement that hands possession to the developer otherwise transfers the developer's share, so the postponed capital gain and the business profit on that share both fall in the year of the agreement; the words sold or otherwise transferred are not confined to a sale. The owner's argument is that the stock is realised only when the flats or the developer's undivided share are conveyed, and that section 2(47), which defines transfer in relation to a capital asset, does not in terms reach stock. The Pune Tribunal placed the charge later in Vilas Babanrao Rukari (HUF) (May 2018), where land converted on 19 January 2006 was given under a registered agreement of 24 February 2006 and the gain was held chargeable in assessment year 2011-12, when the project was completed and the flats were handed over to buyers, and in Ramdas Haribhau Kakade (November 2017), on the Revenue's appeal heard without the owner appearing, where the owner had himself offered the gain in the agreement year and the Tribunal held that, without a municipal sanction, the stock "was not even ready for development" (para 17), so section 54B could not be claimed in that year (para 18). The Karnataka High Court in Chaitanya Properties (February 2016) dismissed the Revenue's appeal against a Tribunal order quashing the reopening as a change of opinion, as raising facts, so there is no High Court ruling on the merits. The Tribunal decisions place the charge at completion or sale, and the drafting of the agreement still decides most cases.
Whether the conversion is genuine, and when it happened
A conversion recorded shortly before a joint development agreement freezes the capital gain and moves later appreciation into business income. The Revenue's argument against an owner who claims to have converted is that conversion is a fact proved by conduct, and a book entry by a person who carries on no business is not treatment as stock of a business carried on by him. The Revenue has also run the theory the other way: in Amrendra Kumar (Delhi Tribunal, September 2026) the Assessing Officer, relying on the owner's own reply to a show cause notice admitting a conversion in 2016, treated an unregistered agreement of 7 April 2016 as a conversion, taxing Rs 1,93,78,293 as a capital gain and Rs 2,20,98,985 as business income on flats later conveyed to the owner's wife, and the Tribunal deleted the capital gain because conversion was not proved and the owner was not in the real estate business (para 7), without dealing with the admission, and deleted the business income because the conveyances to the wife, for which nothing was paid, were not sales (paras 8 to 11). The Telangana and Andhra Pradesh High Court in Devineni Avinash (October 2018), rejecting owners' plea in a wealth-tax appeal that land given for development the day after purchase was stock, said that mere execution of a development agreement does not by itself show an intention to carry on business. The owner's reply is that the words or its treatment by him as stock in trade accept a unilateral act, and that the fair market value on conversion is the approved valuer's figure, which the Commissioner (Appeals) adopted in place of the stamp duty value, as the Pune Tribunal upheld in Vilas Babanrao Rukari (paras 17 and 21). The question remains one of fact in each case.
Indexation and the rate where conversion and sale straddle 23 July 2024
Indexation under the second proviso to section 48 is available only where the transfer takes place before 23 July 2024, and section 112(1) fixes the twenty or twelve and a half per cent rate by the same date. The owner's argument is that the transfer is the conversion under section 2(47)(iv) and that section 45(2) moves only the year of charge, so a conversion before 23 July 2024 keeps indexation and the old rate even if the flats are sold later. The Revenue's argument is that the gain is income of the year of sale and that the computation should follow the law in force for that year. The owner has the words of the definition; the Revenue has the year of charge. For a resident individual or Hindu undivided family the stakes are smaller, because the second proviso to section 112(1)(a) caps the tax on land acquired before 23 July 2024 at what the pre-2024 law with indexation would charge; the point bites on non-residents, firms, companies and trusts. No decision on the point was traced.
Valuing the consideration for stock given under a joint development agreement
In L.K. Trust the trust's section 45(2) gain was not in dispute, and the valuation fight concerned its business income. The Revenue's approach was the developer's construction cost, Rs 7,853 a square foot in the assessment (Rs 7,706 in the show cause notice), and the Commissioner (Appeals) sustained about Rs 4,241 a square foot. The Bangalore Tribunal held that the developer's cost "is not the price paid to the assessee" (para 8.8), that guideline value could be adopted as the fair market value of the constructed area under section 50D, read with section 43CA (paras 8.14, 8.15 and 9), though section 50D in terms applies to capital gains, and that the exercise was tax neutral because a higher value for the stock becomes a higher cost on its sale (para 9.2). The Revenue's further argument is section 43CA, which takes stamp duty value where stock that is land or building is transferred for less; the owner answers with its tolerance and agreement-date rule and with the difficulty of comparing a stamp duty value with consideration in kind not yet built. L.K. Trust is the only worked decision found; it used section 43CA only to value the area received, and whether section 43CA substitutes a stamp duty value for consideration in kind under an area-sharing agreement is undecided.