Section 54 of the Income Tax Act: Capital Gains Exemption Under Section 54

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.

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 they are held for more than 12 Months:

• Listed securities
• Units of Equity oriented fund
• Zero-coupon bond

For Section 54 of the Income Tax Act, the house property should be held for more than 24 months to consider an asset as a long-term capital asset.

LTCG and STCG Rates in 2023-24 and 2024-25 - Comparison

Budget 2024, announced on 23rd July 2024, brought about certain changes in the long-term and short-term capital gains tax rates and holding periods. Given below is a table showing the comparison between the capital gains tax rates in FY 23-24 and FY 24-25.

Taxation for mutual funds

Who is Eligible to Avail of the Exemption 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. Given below are the conditions of eligibility for section 54 exemption.

• Only individuals or HUFs 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 of the Income Tax Act.

How to Calculate 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 are liable for taxation will be the balance of both, which is Rs 15,00,000 ( 35,00,000-20,00,000).

Budget 2023 Update (Section 54 exemption chart):

Provisions for Transfer of Property Under Section 54

If the new house is sold within a period of 3 years from the date of purchase/construction, then the exemption claimed will be reversed and become taxable in the year of sale. In this case, let’s consider 2 different scenarios -

Case 1. The cost of new house purchased is less than the capital gains calculated on the sale of property

When the new property is sold within 3 years of the date of purchase, the cost of acquisition becomes nil and the balance amount becomes taxable.

Example -
Mr.A sold residential property in May 2022 leading to a capital gain of Rs.30,00,000. He purchased a residential property in June 2022 for Rs.18,00,000.
The new residential property is sold in December 2023 for Rs.35,00,000.

Capital Gains in 2022:

Capital Gains in 2023:

Case 2 - Cost of new house purchased is more than the capital gains calculated on selling the original house

If the cost of new asset is more than the capital gains, then the entire capital gain will be exempted. However, if the new property is sold within 3 years, then the capital gains will be taxable.

Example -
Mr.Z sold a residential property leading to a capital gain of Rs. 25,00,000 in June 2021. In October 2021, Mr.Z purchased a new residential house property worth Rs.40,00,000. In January 2023, he sold this new residential property for Rs.55 lakhs. Here’s how the taxable capital gains will be calculated -

Capital Gains for 2021 -

Capital Gains for 2023 -

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 either.

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 Gain 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 capital gain tax on property.

Impact of the Finance Act 2023 on Section 54

The Finance Act 2023 introduced a significant change to Section 54 of the Income Tax Act, impacting the maximum exemption allowed for capital gains arising from the sale of residential property. Here's how it affects individuals:

• Previous Rule: Before the Act, there was no limit on the amount of capital gain exemption one could claim under Section 54 by investing in a new residential property.
• New Rule: Effective from the Assessment Year 2024-25 (April 1, 2024, onwards), the maximum exemption allowed under Section 54 is capped at Rs. 10 crore. This means:
  If the cost of the new residential property exceeds Rs. 10 crore, the excess amount invested will not be considered for exemption calculation.
  Only the portion of the capital gain up to Rs. 10 crore invested in the new property will be exempt from tax.

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.

Points to Note

• The property that is purchased after selling should be bought in the seller’s name and not in 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 with respect to 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 with respect to 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.

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