Under the Income Tax Act, 1961, individuals and Hindu Undivided Families (HUFs) can claim exemptions from capital gains tax by reinvesting the proceeds from the sale of a capital asset in specified avenues. These exemptions are designed to encourage reinvestment and reduce the tax burden on taxpayers. Below are the key exemptions available under various sections of the Act:
Section 54: Exemption on Sale of Residential Property
- Applicability: Available to individuals and HUFs.
- Condition: To qualify for benefits under Section 54, the capital gain must originate from the sale of a long-term residential property, with its income falling under the category of “Income from house property.”
- Exemption: The capital gains can be exempted if the taxpayer invests the amount in:
- Purchasing one residential propertyin India, or
- Constructing one residential propertyin India.
- Time Limit:
- Purchase: Must be made 1 year beforeor 2 years after the date of sale.
- Construction: Must be completed within 3 yearsfrom the date of sale.
- Amount of Exemption: Amount of Exemption shall be lower of:
- Cost of New Asset or,
- Capital Gain Amount
- Lock-in Period: The new property must be held for at least 3 years; otherwise, the exemption will be revoked.
Although if new asset is transferred within 3 years of date of purchase or construction then, cost of acquisition shall be reduced by exempted capital gain. For example, if assessee claims exemption under this section, by purchasing a residential property within specified period, and then transfer such property within 3 years of date of acquisition, so while computing capital gain at the time of transfer, cost of acquisition shall be considered as nil.
- Option for Two Residential Houses:
For taxpayers with capital gains not exceeding two crore rupees, there exists an option to invest in or construct two residential houses in India. The second proviso emphasizes the term “two residential houses” for such cases. But this option can be exercised only once in a lifetime.
In the case of CIT v. Syed Ali Adil (2012) [2012] (AP) Andhra Pradesh High Court held that where the assessee has acquired two adjacent flats and effected modifications to make them a single flat, it was immaterial that flat was acquired from two different sellers and separate sale deeds. Hence both flats shall be deemed single house property for the purpose of exemption u/s 54.
- Deposit Requirement:
In case, residential property acquired or constructed after sale of capital asset, assessee is required to deposit such amount made in a specified bank or institution under a government-approved scheme before due date of filing of return.
The deposited amount should be utilized for the purchase or construction of the new property within the specified time frame. Failure to do so results in the unutilized amount being treated as income in the year when the two/three year period from the original asset`s sale expires.
- Recent Amendments:
The latest amendment introduces a significant change in cases where the cost of the new asset exceeds ten crore rupees. In such scenarios, the amount exceeding ten crore rupees is no longer taken into account for calculating exemption of Section 54. In such scenarios, only the amount up to Rs.10 crores for acquisition new residential house property is considered for tax calculations.
For example, If the cost of the new residential property is fifteen crore rupees, only the first ten crore rupees will be considered for calculating exemptions under Section 54. The amendments will come into effect for the financial year starting April 1, 2024.
Section 54EC: Exemption on Investment in Specified Bonds
- Applicability: Available to individuals and HUFs.
- Condition: The capital gains must arise from the sale of a long-term capital asset (e.g., land, building, or both).
- Exemption: The capital gains can be exempted if the amount is invested in specified bondsissued by:
- National Highways Authority of India (NHAI), or
- Rural Electrification Corporation (REC), or
- Any other bond notified by the government.
- Time Limit: The investment must be made within 6 monthsfrom the date of sale.
- Maximum Investment Limit: ₹50 lakh per financial year.
- Lock-in Period: The bonds must be held for 5 years; otherwise, the exemption will be revoked.
Section 54F: Exemption on Sale of Any Long-Term Asset (Other than Residential Property)
- Applicability: Available to individuals and HUFs.
- Condition: The capital gains must arise from the sale of a long-term capital asset other than a residential property(e.g., land, gold, shares, etc.).
- Exemption: The entire capital gains can be exempted if the net sale considerationis invested in:
- Purchasing one residential propertyin India, or
- Constructing one residential propertyin India.
- Time Limit:
- Purchase: Must be made 1 year beforeor 2 years after the date of sale.
- Construction: Must be completed within 3 yearsfrom the date of sale.
- Condition: The taxpayer should not own more than one residential property(other than the new one) on the date of sale.
- Amount of Exemption: The exemption is proportional if the entire net sale consideration is not reinvested.
- Lock-in Period: The new property must be held for at least 3 years; otherwise, the exemption will be revoked.
- Tax Treatment of Capital Gains:
If the cost of the new asset equals or exceeds the net consideration of the original asset, the entire capital gain is exempt from taxation under Section 45. However, if the cost is less, a proportionate part of the capital gain is exempt, calculated based on the ratio of the new asset`s cost to the net consideration.
Simply, if cost of new asset acquired is less than net consideration of asset transferred, in that case, exemption will be calculated in the following manner:
Cost of New House * Capital Gains/Net Consideration
- Other Conditions to avail this exemption:
- On the date of transfer of original asset, assessee should not own more than one residential house.
- Assessee should not purchase any other house (other than the house on basis of which exemption is claimed) within 2 years or construct within 3 years after date of transfer. If above conditions are not satisfied, then exempt Capital Gain shall become taxable in the year in which above condition are violated.
- Deposit Requirement:
To claim exemption under this section, assessee is required to deposit such amount made in a specified bank or institution under a government-approved scheme before due date of filing of return.
The deposited amount should be utilized for the purchase of the new residential property within the specified time frame. Failure to do so results in the unutilized amount being treated as income in the year when the two/three year period from the original asset`s sale expires.
Related Case Law: Commissioner of Income Tax Vs Shri Kamal Wahal, Delhi HC (2013) [2013] (DELHI)
The appeal raises the question of whether the Tribunal was correct in allowing a deduction of Rs. 51,25,100 under Section 54F of the Income Tax Act 1961. The appellant inherited a 50% share in a residential house in Delhi in 2003, and the Tribunal noted that Section 54F, encouraging investment in residential houses, should be liberally interpreted.
The appellant purchased the property solely in his wife`s name, using funds entirely from the sale proceeds with no contribution from his wife.
Applying purposive construction and considering Section 54F`s objective, the court answered the question of law in the affirmative, favoring the appellant and dismissing the appeal.
Section 54B: Exemption on Sale of Agricultural Land
- Applicability: Available to individuals and HUFs.
- Condition: To benefit from Section 54B, the capital gain must arise from the transfer of agricultural land used by the assessee, or their parent, or an HUF for agricultural purposes in the 2 years preceding the transfer. Within 2 years after the transfer, the assessee must purchase another piece of land for agricultural use. This exemption is available only to Individual and HUFs.
- Exemption: Amount of Exemption shall be lower of:
- Cost of New Asset or,
- Capital Gain Amount
Although if new asset is transferred within 3 years of date of purchase or construction then, cost of acquisition shall be reduced by exempted capital gain. For example, if assessee claims exemption under this section, by purchasing a land for agricultural use within specified period, and then transfer such land within 3 years of date of acquisition, so while computing capital gain at the time of transfer, cost of acquisition shall be considered as Nil.
- Time Limit: The new agricultural land must be purchased within 2 yearsfrom the date of sale.
- Amount of Exemption: The exemption is limited to the amount of capital gains or the amount reinvested, whichever is lower.
- Deposit Requirement:
To claim exemption under this section, assessee is required to deposit such amount made in a specified bank or institution under a government-approved scheme before due date of filing of return.
The deposited amount should be utilized for the purchase of the new land within the specified time frame. Failure to do so results in the unutilized amount being treated as income in the year when the two/three year period from the original asset`s sale expires.
In the matter involving Gurunam Singh [2008] (P&H), the court established that if the taxpayer acquires a residential house in the spouse`s name, having personally disbursed the entire purchase amount and essentially designating the spouse as the property owner, such an arrangement should not alter the essence of the transaction. In fact, the court expressed support for such agreements, emphasizing their role in empowering women. The court also noted that the government has introduced several initiatives endorsing shared ownership with spouses. Additionally, it was underscored that in the case at hand, the taxpayer should be regarded as the de facto owner of the property.
Section 54D: Exemption on Compulsory Acquisition of Land or Building
- Applicability: Available to individuals and HUFs.
- Condition: The capital gains must arise from the compulsory acquisition of land or building forming part of an industrial undertaking.
- Exemption: The capital gains can be exempted if the amount is reinvested in:
- Purchasing another land or building, or
- Constructing another building for shifting or re-establishing the industrial undertaking.
- Time Limit: The new asset must be purchased or constructed within 3 yearsfrom the date of receipt of compensation.
- Amount of Exemption: The exemption is limited to the amount of capital gains or the amount reinvested, whichever is lower.
Section 54G/54GA: Exemption for Shifting Industrial Undertaking to Rural/Urban Areas
- Applicability: Available to individuals and HUFs.
- Condition: The capital gains must arise from the transfer of assets due to shifting of an industrial undertaking from an urban area to a rural area (Section 54G) or to a Special Economic Zone (Section 54GA).
- Exemption: The capital gains can be exempted if the amount is reinvested in:
- Purchasing new plant and machinery, land, or building, or
- Shifting and transferring the industrial undertaking.
- Time Limit: The investment must be made within 1 year beforeor 3 years after the date of transfer.
Section 10(37): Exemption on Compensation from Compulsory Acquisition of Agricultural Land
- Applicability: Available to individuals and HUFs.
- Condition: The capital gains must arise from the compulsory acquisition of agricultural land located in an urban area.
- Exemption: The entire capital gains are exempt if the land was used for agricultural purposes by the taxpayer or their parents for at least 2 yearsbefore the acquisition.
