[Section 54] : Exemption of Capital Gain arising on Transfer of Residential House Property

Exemption of Long-term Capital Gains Tax under Section 54

Understanding of Section 54

When an individual sells a residential house property, they are liable to pay capital gains tax on the profit made from the sale. However, under Section 54 of the Income Tax Act, 1961, individuals can claim an exemption on the capital gains arising from the transfer of a residential house property under certain conditions.

Conditions for Exemption

In order to avail the exemption under Section 54, the following conditions must be fulfilled:

  1. The property being transferred must be a residential house property.
  2. The capital gains must arise from the transfer of this residential house property.
  3. The taxpayer must purchase or construct a new residential house property within the specified time period.
  4. The new residential house property must be purchased one year before or two years after the date of transfer, or it should be constructed within three years from the date of transfer.

It is important to note that the exemption is only available for long-term capital gains, which arise when the property is held for more than two years. Short-term capital gains are not eligible for this exemption.

If all these four conditions are satisfied then the assessee can claim the exemption under section 54.

Calculation of Exemption

The amount of exemption that can be claimed under Section 54 is calculated as follows:

If the cost of the new residential house property is equal to or more than the capital gains, the entire capital gains amount is exempt.

If the cost of the new residential house property is less than the capital gains, the exemption is limited to the amount invested in the new property.

For example, if the capital gains amount to Rs. 50 lakhs and the new residential house property is purchased for Rs. 40 lakhs, the exemption will be limited to Rs. 40 lakhs only.

Investing in Capital Gains Account Scheme

If the taxpayer is unable to invest in a new residential house property within the specified time period, they have the option to deposit the capital gains amount in a Capital Gains Account Scheme. This amount can be utilized for the purchase or construction of the new residential house property in the future.

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Conclusion

Section 54 of the Income Tax Act provides individuals with an opportunity to avail an exemption on the capital gains arising from the transfer of a residential house property. By fulfilling the specified conditions and investing in a new property, taxpayers can reduce their tax liability and maximize their gains. It is advisable to consult a tax professional or chartered accountant for accurate guidance and assistance in claiming this exemption.

Circumstance, where the assessee can acquire Two Residential Houses instead of One

Where the amount of the capital gain does not exceed Rs. 2 Crore, the assessee may, at his option, purchase or construct two residential houses in India, and where such an option has been exercised,—

(a)        the provisions of this sub-section shall have effect as if for the words “one residential house in India”, the words “two residential houses in India” had been substituted;

(b)        any reference in this sub-section and sub-section (2) to “new asset” shall be construed as a reference to the two residential houses in India.

Further, where during any assessment year, the assessee has exercised the option referred to in the first proviso, he shall not be subsequently entitled to exercise the option for the same or any other assessment year.

Therefore, now the exemption can be claimed for purchase/construction of two residential houses instead of one. This benefit is available only when the capital gain does not exceed Rs. 2 Crore. Further, this benefit is available only once in a life time.

Quantum of Deduction

(1)        Amount of long-term capital gain; or

(2)        Amount invested in the purchase or construction of the residential house,

whichever is less.

Judicial decisions

(1)        The assessee sold his residential property and invested the capital gain within the stipulated time in the construction of a new floor on another house owned by him by demolishing the existing floor, it was held that he was entitled to exemption under section 54.

(2)        In case of assessee’s death during the stipulated period, benefit of exemption under section 54(1) is available to legal representative if the required conditions are satisfied by the legal representative..

(3)        Exemption available for transfer of a part of house if the same is an independent unit

(4)        Where an assessee who owned a house property, sold the same and purchased another property in the name of his wife, exemption under section 54 shall be allowable.

(5)        Where the assessee had partly invested the capital gains on the purchase of another house and partly on the construction of additional floor to the house so purchased within the prescribed time limit, it was held that the Income-tax Officer was not justified in restricting exemption to investment on purchase only, holding that the exemption under section 54 was admissible either for purchase or for construction but not for both..

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(6)        The construction of the new house may start before the date of transfer, but it should be completed after the date of transfer of the original house.

IMPORTANT NOTES :

1.         Exemption is available under section 54 in respect of a residential house which may be let out or self- occupied.

2.         As per a circular of CBDT, the cost of the land is an integral part of the cost of the residential house, whether purchased or constructed. [Circular No. 667, dated 18.10.1993].

Key Points of Section 54B

Section 54 of the Income Tax Act in India provides an exemption from capital gains tax on the sale of a residential house property if certain conditions are met. Here are the key details related to this provision:

1.   Eligibility:

To be eligible for the exemption under Section 54, the following conditions must be met:

  1. The capital asset being transferred should be a residential house property.
  2. The property should have been held by the taxpayer for at least two years as a long-term capital asset.
  3. The capital gains should arise from the transfer of this residential house property.

2.   Utilization of Sale Proceeds:

The exemption is available if the sale proceeds from the residential house property are utilized to purchase or construct another residential house property. This purchase or construction must take place within the stipulated time frame.

3.   Time Limit for Reinvestment:

The taxpayer can invest in the new residential house property either one year before the date of transfer or within two years after the date of transfer of the original residential house property. In case of construction of a new house, it should be completed within three years from the date of transfer.

4.   Exemption Amount:

The exemption under Section 54 is limited to the amount of capital gains arising from the transfer of the original residential house property. In other words, the entire capital gains amount is eligible for exemption if it is reinvested in the specified assets.

5.   Tax Implications:

If the entire amount of capital gains is not reinvested in the specified assets within the prescribed time frame, the unutilized portion of the capital gains will be taxable in the year of transfer.

6.   Conditions for Continuance of Exemption:

The new residential house property acquired or constructed must be located in India. Additionally, if the new house is transferred or converted into any other type of asset within three years from the date of its acquisition or construction, the exemption granted under Section 54 will be revoked, and the capital gains tax will become payable.

7.   Number of Properties:

As per the original provisions of Section 54, taxpayers could claim the exemption for the purchase or construction of only one residential house property. However, the Finance Act, 2019 introduced an amendment allowing individuals to claim this exemption for the purchase of up to two residential house properties, provided the capital gains from the sale of the original property do not exceed Rs. 2 crores. This amendment is applicable from the assessment year 2020-21 onwards.

Scheme of Deposit in Capital Gains Accounts Scheme, 1988:

Although under section 54, the assessee is given 2 years to purchase the house property or 3 years for construction of the house property, but the capital gain on the transfer of the original house property is taxable in the previous year in which the transfer took place. The return of income of that previous year is to be submitted in the relevant assessment year on or before the specified date. Hence the assessee will have to take a decision for the purchase/construction of the house property till the date of furnishing of the return otherwise the capital gain would become taxable.

To avoid the above situation, the Income-tax Act has specified an alternative in the form of a deposit under the Capital Gains Accounts Scheme.

The amount of capital gain, which is not utilised by the assessee for the purchase or construction of the new house before the date of furnishing of the return of income, should be deposited by him under the Capital Gains Accounts Scheme, before the due date of furnishing the return. The proof of such a deposit shall be attached with the return. In this case, the amount already utilised by the assessee for the purchase/construction of the new house, along with the amount so deposited, shall be deemed to be the cost of the new house and shall be eligible for exemption.

Consequences where the amount deposited in the Capital Gains Accounts Scheme is Not Utilised for the Purchase or the Construction of a Residential House within the specified period:

in this case, the amount not so utilised shall be charged as capital gains of the previous year in which the period of 3 years from the date of transfer of the original asset expires and it will be long-term capital gain of that previous year. In that case, the assessee shall be eligible to withdraw the amount from the scheme.

Consequences where the New House Purchased and/or Constructed is Transferred within a period of 3 years of its Purchase or Construction:

In this case, for the purpose of computing capital gain on such transfer, cost of acquisition of the new house property shall be reduced by the amount of capital gain exempt under this Section, i.e., Section 54 earlier. Such capital gain will be:

(i)         short-term capital gain if the new house is transferred within 2 years.

(ii)        long-term capital gain if the house property is transferred after 2 years but before 3 years from the date of its acquisition. Benefit of indexation of the net cost of acquisition (i.e., cost of acquisition capital gain exempt under section 54 earlier) will also be allowed.

Further, the assessee can again claim the exemption under section 54, if all other conditions are satisfied.

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