Legal Risks and Challenges of Real Estate Tokenization

Introduction

The rise of real estate tokenization is transforming how investors buy, sell, and manage property. By converting ownership interests in real estate into digital tokens on a blockchain, it promises increased liquidity, transparency, and fractional ownership opportunities. For Indian investors, this innovation offers access to high-value assets that were previously out of reach.

However, while the concept is technologically sound, the legal landscape in India remains uncertain. Questions around title ownership, securities classification, taxation, anti-money laundering (AML) compliance, and foreign investment make real estate tokenization legally complex.

This article explores the key legal risks and challenges of real estate tokenization in India, helping developers, investors, and legal advisors understand how to navigate this evolving domain safely.

What is Real Estate Tokenization?

Real estate tokenization refers to the process of converting ownership or rights in a property into digital tokens using blockchain technology. Each token represents a specific share or interest in a property, similar to owning equity in a company or units in a real estate investment trust (REIT).

These tokens can be:

• Equity tokens: Representing ownership in the property or an SPV that holds the property.
  

• Debt tokens: Representing debt secured against real estate.
  

• Utility tokens: Representing rights to use or access property services.
  

By fractionalizing assets into tokens, investors can buy smaller shares of large properties and trade them on digital platforms — theoretically improving liquidity and efficiency.

But unlike traditional shares or REIT units, tokenized real estate assets face an unclear legal framework, especially when property laws, securities laws, and blockchain regulations intersect.

Why Legal and Regulatory Clarity Matters

Real estate tokenization relies on blockchain’s decentralized records, but legal systems depend on centralized registries like land records, stamp offices, and company registers.

This creates a fundamental tension:

• Blockchain may record token transfers in seconds,
  

• But the legal ownership of property in India still depends on physical documents and registration under the Registration Act, 1908.
  

Without a legal bridge between these systems, token ownership might not equate to legal title. This misalignment is the root cause of many of the legal challenges associated with tokenized real estate.

1. Regulatory Uncertainty and Overlap

The biggest challenge for real estate tokenization in India is the lack of a clear regulatory framework. Multiple agencies may claim jurisdiction, including:

• SEBI (Securities and Exchange Board of India) – for security tokens.
  

• RBI (Reserve Bank of India) – for payment and currency aspects.
  

• MCA (Ministry of Corporate Affairs) – for SPV structures and compliance.
  

• State land authorities – for property title and stamp duty.
  

Currently, India’s laws do not explicitly recognize tokenized ownership of real estate. Depending on the structure, tokens could be classified as:

• Securities, if they represent fractional investment.
  

• Units in a REIT or SPV, if structured through a regulated vehicle.
  

• Unregulated digital assets, if issued without oversight.
  

This ambiguity creates high compliance risks. If regulators classify tokens as securities, issuers would need to comply with SEBI’s stringent rules on prospectus filings, disclosures, and investor protection.

2. Property Title and Enforceability

India’s property transactions rely on physical deeds and registered documents. Blockchain records cannot replace these legally recognized documents under current law.

Even if a token represents ownership in a property, land title remains with the person or entity listed in the official land registry. Hence, token holders might not have enforceable rights in court unless the underlying ownership structure (e.g., an SPV or trust) is properly designed.

To legally align blockchain ownership with property rights, projects must:

• Use a registered SPV that owns the property.
  

• Tokenize shares in the SPV, not the property itself.
  

• Ensure proper legal documentation linking tokens to ownership rights.
  

3. Securities Law and Investor Protection

In most cases, tokenized real estate offerings involve fractional ownership and profit sharing, which can fall within the definition of “securities” under the Securities Contracts (Regulation) Act, 1956.

If classified as securities, issuers must comply with:

• SEBI’s prospectus and disclosure norms.
  

• Intermediary registration requirements for platforms.
  

• Restrictions on public offerings to unaccredited investors.
  

Failure to comply can result in severe penalties, de-listing of platforms, and legal prosecution. SEBI has already warned against unregistered tokenized asset offerings, emphasizing the need for investor protection.

4. AML, KYC, and FEMA Compliance

Tokenization can attract cross-border investors, but that brings foreign exchange and anti-money laundering (AML) risks.

Under India’s Prevention of Money Laundering Act (PMLA) and Foreign Exchange Management Act (FEMA), real estate transactions involving foreign investment require careful structuring.

Challenges include:

• Determining whether foreign investors can hold tokens representing Indian real estate.
  

• Conducting robust Know Your Customer (KYC) and Anti-Money Laundering (AML) checks.
  

• Ensuring all transactions comply with FEMA guidelines on capital inflows and repatriation.
  

Failure to comply can expose issuers and platforms to enforcement actions by FIU-IND, ED, and RBI.

5. Tax Ambiguities

The taxation of real estate tokens is another grey area. Uncertainties include:

• Stamp duty: Whether it applies to token transfers or only to the underlying property.
  

• Capital gains tax: How to calculate it when tokens represent fractional interests.
  

• GST: Whether token transactions constitute supply of goods or services.
  

Additionally, tokens could be treated as “virtual digital assets” under India’s Income Tax Act, attracting 30% tax on gains and 1% TDS on transfers under Section 194S.

This overlapping framework can lead to double taxation or non-deductible losses, reducing investor appeal.

6. Smart Contract and Cybersecurity Risks

Smart contracts automate transactions, distributions, and ownership transfers. However, they are not legally recognized contracts under the Indian Contract Act, 1872, unless supported by verifiable digital signatures and enforceable terms.

Common risks include:

• Coding errors that lead to loss of tokens.
  

• Hacks and key thefts from custodial wallets.
  

• Irreversible on-chain transactions with no legal recourse.
  

Issuers should ensure third-party audits, cybersecurity insurance, and multi-signature custody to mitigate these risks.

7. Governance and Minority Rights

When hundreds of investors hold fractional tokens of a property, decision-making becomes complex. Disputes can arise over:

• Maintenance and repairs.
  

• Rental terms and tenant selection.
  

• Sale or redevelopment of the property.
  

Without clear governance rules, token holders may face deadlocks. A well-drafted tokenholder agreement or trust deed must define:

• Voting rights and thresholds.
  

• Dispute resolution procedures.
  

• Roles of property managers and trustees.
  

8. Liquidity and Platform Risks

While tokenization is meant to improve liquidity, secondary markets for real estate tokens are still underdeveloped in India.

Trading is often limited to private platforms that lack regulatory approval. If such a platform shuts down, investors may lose access to both tokens and underlying assets.

Until SEBI or another regulator permits regulated exchanges for tokenized securities, liquidity will remain largely theoretical.

Practical Recommendations for India

To navigate these legal challenges, stakeholders should follow these best practices:

1. Define the token’s legal nature early — whether it’s equity, debt, or utility.
   

2. Use compliant structures such as SPVs or REITs to link tokens to enforceable rights.
   

3. Engage with regulators like SEBI and RBI proactively, especially under sandbox frameworks such as GIFT City’s IFSCA sandbox.
   

4. Implement strong KYC/AML systems to meet FIU-IND and PMLA standards.
   

5. Obtain tax opinions and, if possible, advance rulings to avoid future disputes.
   

6. Conduct smart contract audits and ensure insured custody solutions.
   

7. Draft governance frameworks to protect token holders’ voting and economic rights.
   

The Way Forward

For India, real estate tokenization is both an opportunity and a challenge. The technology offers democratized access and efficiency, but the legal ecosystem is still catching up.

Until a dedicated regulatory framework emerges, stakeholders should focus on compliance-first token design — aligning blockchain innovation with existing property, securities, and tax laws.

Countries like Singapore, Switzerland, and the UAE have introduced sandbox regimes for tokenized assets. India, through initiatives in GIFT City, is gradually moving in that direction, but mainland clarity from SEBI, RBI, and MCA is still awaited.

Conclusion

Real estate tokenization is redefining property investment by merging blockchain innovation with tangible assets. Yet, without legal certainty, this innovation can quickly become a compliance nightmare.

The legal risks — from ownership disputes and securities violations to tax ambiguity and cybersecurity threats — are real and substantial. Developers, investors, and advisors must proceed carefully, structuring transactions that comply with India’s property, securities, and AML frameworks.

As regulators evolve and legal clarity improves, tokenized real estate could unlock billions in fractional investments, paving the way for a transparent, inclusive, and globally connected Indian property market.