Important Keyword: Capital Gains Exemption, Income Heads, Income Tax, Section 54.

Section 54: Capital Gain Exemption on Sale of House Property

When individuals decide to sell their residential property, they often do so for reasons like job changes, lifestyle adjustments, or retirement. While this transaction incurs capital gains tax, the primary motive isn’t usually profit-making but rather finding a more suitable home. Recognizing this, the Income Tax department offers Capital Gain Exemption under Section 54 of the Income Tax Act.

This provision allows taxpayers to reduce their Capital Gain Tax by fulfilling certain conditions. By meeting these criteria, individuals can claim exemptions on the sale of residential properties, providing them with financial relief during transitions in their lives.

Capital Gain Exemption under Section 54

Exemption provided under Section 54 of the Income Tax Act offers relief on capital gains arising from the sale of one residential house property when the proceeds are invested in the purchase or construction of another residential house property. The exemption amount is determined as the lower of:

1. The cost of the new residential house property.
2. The capital gains realized from the sale of the residential house property.

To be eligible for capital gain exemption under Section 54, taxpayers must meet the following criteria:

1. The taxpayer must be an Individual (including NRI) or HUF; this benefit is not applicable to companies, LLPs, or firms.
2. The asset sold must be a Long Term Capital Asset, specifically a residential house (including building or lands appurtenant to it).
3. Income generated from the house should be chargeable under the head “Income from House Property.”
4. If the capital gains amount exceeds ₹2 crore, the taxpayer must purchase or construct one residential house in India within specific timeframes.
5. If the capital gains amount is not more than ₹2 crore, the individual or HUF has the option to either purchase two residential houses or construct two residential houses within prescribed time limits.

These provisions aim to facilitate homeownership and encourage investment in residential properties, contributing to the broader goal of promoting housing for all.

Quantum of Exemption under Section 54

The amount of exemption under Section 54F is determined based on specific criteria:

1. If the cost of the new residential house is greater than or equal to the Long-term Capital Gain:
   • The entire Long-term capital gain is exempt.
2. If the cost of the new residential house is less than the Long-term Capital Gain:
   • Long-term Capital Gain to the extent of the cost of the new residential house is exempt.

Note: In Budget 2023, Finance Minister Nirmala Sitharaman capped capital gain tax exemption at ₹10 crores on the sale of the first residential property under section 54, effective from 1st April 2023.

Example: Jayni sold a house property in FY 2023-24 for ₹40 crores, purchased in FY 2016-17 for ₹20 crores. She bought a new house property worth ₹18 crores in another city. Jayni’s deduction under section 54 is as follows:

In this scenario, Jayni can claim an exemption of up to ₹10 crores since the house property was sold after April 1, 2023. However, taxes will be levied at a rate of 20% on the remaining amount exceeding ₹10 crores, which is ₹3,63,63,636.

Consequences of Transfer of New House Property

The lock-in period of 3 years is applicable when a taxpayer claims an exemption under Section 54 of the Income Tax Act. Different scenarios can unfold:

Situation 1: If the taxpayer sells the new residential house within 3 years from the date of purchase or construction, and the cost of the new house purchased is less than the Capital Gains:

Consequences: The exemption under Section 54 is revoked. The entire sales value of the new house property becomes taxable as capital gains. In this case, the cost of acquisition is considered as NIL.

Situation 2: If the taxpayer sells the new residential house within 3 years from the date of purchase or construction, and the cost of the new house purchased is more than the Capital Gains:

Consequences: The exemption under Section 54 is withdrawn. However, the taxpayer can still claim the cost of acquisition (Total Purchase Price – Exemption u/s 54) while calculating capital gains.

Situation 3: If the taxpayer sells the new residential house after 3 years from the date of purchase or construction:

Consequences: The exemption under Section 54 remains intact. The taxpayer can claim the index cost of acquisition while calculating the capital gain on the sale of the house property. However, income tax on capital gains must be paid at the rate of 20%.

CGAS Scheme for claiming exemption.

If a taxpayer finds themselves unable to utilize the entirety or a portion of the sales consideration for purchasing or constructing a new property by the due date of submitting their Income Tax Return (ITR), they have the option to deposit the funds in the Capital Gains Deposit Account Scheme (CGAS). By doing so, they can still claim an exemption for the amount already expended on the construction or purchase of the property, in addition to the amount deposited in CGAS.

However, it’s crucial to bear in mind that if the taxpayer fails to utilize the amount deposited in the Capital Gains Account Scheme within the stipulated time frame of 3 years, it will be treated as taxable income for the last year.

Read More: Section 54F: Exemption on sale of LTCA

Web Stories: Section 54F: Exemption on sale of LTCA

Official Income Tax Return filing website: https://incometaxindia.gov.in/