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

Capital gain arising on the transfer of a residential house is exempt Under Section 54 in the following circumstances:

(i)         the asset transferred is a residential house, the income of which is chargeable under the head “income from house property”;

(ii)        the asset transferred is a long-term capital asset and hence there is a long-term capital gain;

(iii)       the asset has been transferred by an individual or a Hindu Undivided Family;

(iv)       the assessee has purchased one residential house in India within one year before or 2 years after the date on which the transfer took place, or constructed one residential house in India within a period of 3 years after the date on which the transfer took place.

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

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..

(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.

 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.