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Section 54 of the Income Tax Act: Capital Gains Exemption
Investing in property has long been a favored strategy for individuals seeking secure and potentially profitable investments. The approach of buying property, holding it for a few years, and selling it at a higher price has been embraced by many as a reliable investment mantra.
In many cases, the owners of residential properties need to sell their houses due to reasons like moving to a new city, switching jobs, retirement, etc. Under Section 54 of the Income Tax Act, if the seller of a residential property acquires or constructs another residential property from that amount, he or she gets benefits from capital gains tax. In this case, the objective is not to earn income from selling the old house but to acquire another suitable house. In other words, when an assessee sells a residential property and purchases or constructs another residential house property, he or she gets exemption from capital gains under Section 54 of the Income Tax Act. In this article, let’s discuss Section 54 of the Income Tax Act.
What is Section 54 of the Income Tax Act, 1961?
We all know that capital gains arise when selling or transferring a capital asset like property, which is taxable in the hands of the assessee/ taxpayer.
Under Section 54 of the Income Tax Act, an individual or HUF selling a residential house property can claim exemption from such capital gains if they invest the proceeds in the acquisition, i.e., purchase or construction, of another residential property. To claim this tax benefit, certain prescribed conditions need to be satisfied. Let’s explore them one by one in this guide.
What is a capital asset?
Any kind of property owned by an assessee is known as a capital asset. It may or may not be connected to business or profession.
|Movable or immovable||Land, buildings, house property, etc.|
|Tangible or intangible||Vehicles, patents, trademarks, leasehold rights, etc.|
|Fixed or circulating||Machinery, jewellery, etc|
What are the different types of capital assets under income tax?
For capital gains, the assets are bifurcated into two major sections:
Short-term capital assets-
Capital assets that the individual holds for not more than 36 months are called short-term capital assets. The gains from selling these assets are called short-term capital gains.
Long-term capital assets-
The assets the assessee holds for more than 36 months are called long-term capital assets. The gains from selling these assets are called long-term capital gains.
If unlisted shares, land, or other immovable property are held for more than 24 months, it is considered a long-term capital asset.
The following assets shall be treated as long-term capital assets if are held for more than 12 Months
- Listed securities
- Units of Equity oriented fund
- Zero-coupon bond
For Section 54; the house property should be held for more than 24 months to consider an asset as a long-term capital asset.
Who is eligible to avail of the benefits under Section 54?
According to this section, when an assessee sells a residential property, a long-term capital asset, and buys another residential house property, he or she can claim a taxation exemption. To avail of this exemption, individuals must satisfy the following conditions:
- Only individuals or HUF are eligible to claim this benefit. The companies cannot reap the benefits of this section.
- The house property; the taxpayer is selling should be a long-term capital asset.
- The property that is to be sold should be a residential house. Income from this property should be charged under the head income from the house property.
- The new residential house property should be purchased either one year before the date of transfer or two years after the date of sale or transfer. In the case of constructing a new house, the individual is given an extended time period to construct a house, i.e., within three years of the date of transfer or sale.
- The house property that is bought should be in India.
If the individual does not fulfill the above conditions, he or she is not liable to claim an exemption under Section 54 of the Income Tax Act. Only such transactions by the taxpayer are eligible for the exemption under Section 54.
What is the amount of capital gain exemption available under Section 54?
Section 54 of the Income Tax Act allows the lower of the two as an exemption amount for a taxpayer:
- Amount of capital gains on transfer of residential property or
- The investment made for constructing or purchasing new residential property
The balance amount (if any) will be taxable as per the Income Tax Act.
With effect from Assessment Year 2024-25 the Finance Act 2023 has restricted the maximum exemption to be allowed under Section 54. In case the cost of the new asset exceeds Rs. 10 crore, the excess amount shall be ignored for computing the exemption under Section 54.
For Example, Mr. Anand sells his house property and earns a capital gain of Rs. 35,00,000. With the sale amount, he purchased a new house for Rs 20,00,000. The exemption under Section 54 will be the lower amount of Rs 20,00,000.
The capital gains that is liable for taxation will be the balance of both, which is Rs 15,00,000 ( 35,00,000-20,00,000).
Which are the mandatory conditions for availing exemptions u/s Section 54?
The taxpayer requires us to fulfill various conditions to avail of the exemptions under section 54. They are as follows:
- After the sale of the old house property, the assessee must purchase new residential property or construct new house property to get benefit from this exemption.
- The new residential property must be purchased either one year before the sale of the old property or two years after the sale of the house property or constructed within three years of the date of transfer or sale.
- Only one house property can be constructed or purchased by the individual to claim the benefit.
- With effect from Assessment Year 2021-22, the Finance Act, 2020, has amended Section 54 to extend the benefit of exemption in respect of investment made in two residential house properties. The exemption for the investment made, by way of purchase or construction, in two residential house properties shall be available if the amount of long-term capital gains does not exceed Rs. 2 crore. If the assessee exercises this option, he shall not be entitled to exercise it again for the same or any other assessment year
- Suppose the individual fails to construct or purchase a new house property within the stipulated period. In that case, he or she can deposit the capital gains proceeds in the Capital Gains Account Scheme in any public sector bank and avail of the exemption from this section.
What is a Capital Gains Account Scheme?
If the assessee is unable to purchase or construct property before the due date of furnishing of return of income for the year of transfer and still wants to save tax he or she can invest/deposit all the unutilized capital gain proceeds of the old house property in Capital Gains Deposit Scheme. In this way, the new property can be purchased later and the capital gains from the proceeds of the sale of old house property will not be taxable too.
The Income Tax Act specifies Various conditions for deposition in the Capital Gains Account Scheme. They are:
- This can be done in authorized/approved bank branches. Rural branches of banks are not included.
- The deposition has to be done before the due date for filing income tax returns.
- The deposited amount has to be utilized to purchase/construct the house as per the provisions of the law.
Non-utilization of the amount deposited in the Capital Gains Account Scheme
Below are the regulations regarding non-utilization of the amount deposited in the Capital Gains Deposit Scheme by the assessee:
The amount deposited in the Capital Gains Deposit Scheme needs to be withdrawn for construction or the purchase of new house property within three years or two years after the date of transfer, respectively. If the assessee does not withdraw this amount within the stipulated time, then the amount of capital gains will be taxable in the hands of the taxpayer. Thus, the assessee has to pay tax on the amount of capital gain.
What are the consequences of transferring the new House Property within 3 years?
If the assessee buys or constructs a new house within the prescribed time limit after selling the old house property, which is a long-term capital asset, he or she can claim an exemption under Section 54.
Further, if he or she wants to sell the new property owned by him or her, the individual must hold the property for a minimum of three years as per section 54.
If he or she sells before the stipulated time, the benefit given to him or her will be withdrawn, and he or she has to pay the tax on capital gains exempted.
- If the builder of the new residential construction fails to hand over the property to the taxpayer within 3 years of purchase, the exemption is still allowed.
If the new house property is sold within three years of its purchase/ construction, then two scenarios can happen. To calculate the taxability, there are two cases:
If the cost of the new house property is less than the capital gains calculated from the sale of the original house property.
In this case, the capital gain is exempt, while the property transfer will now be taxable, and the cost of acquiring new assets will be considered zero.
Mr Swastik sold a long-term residential property in May 2022, for which the capital gains amounted to Rs 40,00,000. In June 2022, he purchased a residential house property worth Rs 20,00,000. Further, he sold the new residential house property (Purchased in June 2022) in December 2023 for Rs. 25,00,000.
Computation of his taxable capital gains will be as follows:
Financial Year 22-23 (Property sold in May 2022)
|Capital gain on the sale of house property||40,00,000.00|
|Less: Exemption u/s 54 on purchase of new residential property||20,00,000.00|
|Taxable Long-term Capital Gains (Financial Year 22-23)||20,00,000.00|
Financial Year 23-24 (Property sold in December 2023)-
|Less: Expenses on transfer||Nil|
|Taxable Short-term Capital Gains (Financial Year 23-24)||25,00,000.00|
The new property was sold within three years from the date of acquisition, hence its cost of acquisition was considered as nil. Thus, the complete sale amount will be taxable as capital gains.
When the cost of the new house property purchased is more than the capital gains calculated on the sale of the original residential property.
In this case, the cost of acquisition of new house property will be reduced by the amount of capital gain exempted.
Mr. Taha has sold a long-term residential property, and the capital gain is Rs 35,00,000 in June 2022. In October 2022, he purchased a new residential house property of Rs 50,00,000. In January 2023, he sold the new residential Property for Rs 65,00,000.
Financial Year 22-23
|Capital gain on sale of house property||35,00,000.00|
|Less: Exemption u/s 54 on purchase of new residential property||35,00,000.00|
|Taxable Long-term Capital Gains (Financial Year 22-23)||Nil|
Financial Year 22-23
|Less: Expenses on transfer||Nil|
|Less: Cost of acquisition of new house||15,00,000.00|
|Taxable Long-term Capital Gains (Financial Year 22-23)||50,00,000.00|
*capital gain claimed for earlier house property
In simple language, we can conclude that, if the new residential property is sold within a period of 3 years from the date of acquisition or from the date of completion of construction, then capital gains exempted will be taxable.
What is the difference between Section 54 and Section 54F?
The Income Tax Act states various tax exemptions against capital gains that save tax for the assessee. Two of the major capital gain exemptions are stated under Section 54 and Section 54F. Both state exemptions on long-term capital gains. There is a major difference between both the exemptions of the tax.
|Section 54||Section 54F|
- The property that is purchased after selling should be bought on the name of the seller and not on any other name to claim the benefit.
- When the cost of the new residential property is lower than the net sale proceeds of the original property, the exemption u/s 54F will be allowed proportionately. One can reinvest the leftover amount under Section 54EC within six months of the transfer, subject to other conditions, to save tax.
Few other examples for a better understanding of Section 54 of the Income Tax Act, 1961.
Mr Shekhar purchased a residential property in April 2014 and sold the same on 21st April 2019 for Rs 12,40,000. Capital gain arising on the sale of the house amounted to Rs 2,00,000. He purchased a new residential house in November 2018 for Rs 6,00,000. Can he claim the benefit of Section 54 in respect of the house constructed in November 2018?
Ans: The assessee purchased the new house property within the period of one year before the transfer of the old house property, which is 21st April 2019; hence he qualifies for the exemption under Section 54. He can claim the benefit of section 54 in respect of his newly purchased house in November 2018.
Q- Mr Kshitij purchased a residential property in April 2018 and sold the same property in April 2019 for Rs 10,40,000. Capital gains arising on the sale of the house amounted to Rs 2,00,000. Can he claim the benefit of section 54 by constructing another residential house from the capital gain of Rs 2,00,000?
Ans: The residential property, in this case, is a short-term capital asset as it is held for a period of less than 24 months. The benefit of Section 54 will not be available to Mr. Kshitij as the period of holding immovable property under this section is less than 24 months before the transfer.
Looking to save on capital gains taxes and secure your financial future? Let our top eCAs guide you through the Capital Gains Account Scheme and Capital Gains Deposit Account Scheme. Book your eCA consultation now and make the most of Section 54 to safeguard your investments and minimize tax liabilities!
Frequently Asked Questions
Q- Is the full amount received from the sale of property taxable?
No, the amount of sale consideration is not taxable.The amount of capital gain which is calculated as per the prescribed calculation is taxable if no exemptions have been claimed.
Q- Who pays TDS in case of the sale of a property?
Any person (Buyer or Transferee) who enters into an agreement with a resident seller for the transfer of an immovable property (land or building or both but not rural agricultural land) is required to deduct TDS @ 1% if the sale consideration or SDV is Rs. 50 lakh or more. Consideration includes all charges such as maintenance fees,car parking,club membership fees, electricity\water fees,
Q- Sale of which type of property can avail the benefit of exemption under section 54?
Exemption under section 54 is only allowed on sale of a residential property which is a long term capital asset for the assessee.
Q- When is the taxpayer benefited under section 54?
When the assessee purchases new residential house property within one year before or two years of the sale of the original house property or constructs new house property within three years of the sale of old property, he or she is liable to get benefit from the exemption under section 54.
Q- How much exemption is allowed under section 54?
Under section 54 of the income tax act, the amount of capital gain on the sale of the original residential house property or the amount of new residential property whichever is less is completely exempt.