How to Save Tax on Sale of Real Estate Property – Section 54?

Transactions of real estate attract hefty taxes that can cause significant reductions in the capital gains of the sellers. To keep taxpayers from paying extensive taxes, the Government has framed a few clauses under section 54 of the Income Tax Act.

Thus, sellers must know how to save capital gains tax on sale of residential property under section 54 in order to maximise their benefits. 

Provision Related to the Purchase of New Property under Section 54

Section 54 of the Income Tax Act offers substantial tax exemptions on the capital gains that an individual or HUF can incur when they invest in a property. This exemption is available if the capital gains are invested in the purchase or construction of the residential property. However, there are several criteria that an individual or HUF must fulfil to stand eligible for tax exemptions.

Eligibility Criteria for Exemptions under Section 54

The essential criteria for these exemptions are as follows: 

• Tax exemption is only available on long term assets. These assets are often referred to as those properties that have been owned for more than two years. 
• Apart from an individual or HUF, no organisation can claim tax benefits from capital gains under this section.
• The property involved must be located inside Indian borders for individuals to claim an exemption on capital gains by selling it.
• It is essential for the property to be a residential property to claim tax exemption on the capital gain during its purchase and sale.
• Individuals must file their income from this sold property under the ‘income from house property’ section to get the exemption. 
• The purchase of a new house must be completed one year prior to the sale or transfer of the current house. Alternatively,  the purchase of a new house can also be completed within 2 years of the sale or transfer of the current house.
• In the case of a house under construction, individuals can avail of an extension of three years to complete the construction using capital gains. However, if the property is sold within 3 years, the exemption can be taken back as well.

With effect from FY 2019-20 a capital gain exemption is available for the purchase of two residential houses in India. The exemption shall be available if the amount of long term capital gains does not exceed Rs. 2 crores. Further, one can exercise this option only once in their lifetime.

From FY 2023 onwards, long term capital gain exemption capping is increased to Rs. 10 crores.

Amount of Exemption Available under Section 54 

Individuals can avail of tax exemptions under Section 54 on the lower of the two amounts:

• Investments for the purchase or construction of a new residential property.
• Capital gains while selling the current residential property.

For instance, if Mr. Thakkar purchases a house for Rs. 10 Lakh and sells it for Rs. 15 Lakhs he will earn a profit and Rs. 5 Lakhs but will also be taxed on this amount of capital gains.  However, he can also reinvest about 3 Lakh from this profit in the purchase of a new house, thus reducing the net capital gain to Rs. 2 lakhs. Moreover, now his taxable gain would also be reduced to Rs. 2 Lakhs. Additionally, sellers must keep in mind that if the capital gain on the current house is equal to the cost of the new house, then they can avail of complete exemption on it.

From the above example, if the cost of the new house is Rs. 5 Lakhs instead of Rs. 3 Lakhs, then the overall capital gain becomes zero. Thus, the seller will not have to pay any tax on capital gains to the Government.

Transfer of Property after Claiming Benefit under Section 54

There are several provisions related to property transfer that a seller must be aware of after claiming tax exemptions on capital gains. These include:

• The cost of the new house is more than the capital gain on the current house

Under such a scenario, the overall capital gain is negligible. Hence, you will not have to pay any tax on capital gains, leading to saving substantially on taxes.

• The cost of a new house is less than the capital gains on the present house

If the cost of the new house is less than the capital gain on the present house and the cost of acquisition is zero, there will be a significant increase in the gains. This results in a subsequent increase in the tax on capital gains.

Apart from this, individuals must also be aware of how to save capital gains tax on the sale of property other than a house under Section 54F.

Provision Related to Purchasing of New Property under Section 54F

Under Section 54F of the Income Tax Act, individuals can claim for an exemption on any real estate property other than a residential one. However, the eligibility for tax exemptions under Section 54F is the same as that of Section 54 of the Income Tax Act. The amount should be invested to purchase one residential house in India within a period of 1 year before or 2 years after the date of transfer. The amount can also be invested, within a period of three years, to construct a residential house in India.

To be noted that in order to claim the full exemption the entire sale receipts have to be invested under this section as compared to only the capital gain in case of exemption under section 54.

Provision Related to Purchasing of New Property under Section 54EC

Under Section 54 EC of the Income Tax Act, individuals can claim tax exemptions if they invest their capital gains on long-term assets in some Government specified bonds. The exemption for long-term capital gains tax under Section 54EC is also subject to some conditions –

1. There is a minimum and maximum limit of investment that can be made in the prescribed bonds. Minimum – 1 bond worth Rs.10,000 and maximum – 500 bonds worth Rs. 50,00,000. The maximum limit of investment is capped at Rs. 50 lakhs. 
2. This exemption is available on bonds of that of specific issuers. Some of them are Power Finance Corporation Limited (PFC), Railway Finance Corporation (RFC), etc. 
3. These bonds must be held for 5 years (5-year lock-in period, earlier it was 3 years) and cannot be transferred to a third party. 
4. The enlisted bonds earn an annual return of 5-6% , which is taxable.
5. To get the tax exemption, the investment has to be made not only within 6 months from the date of sale/transfer of property, but also before the ITR filing due date.

Sellers must also keep some essential things in mind regarding capital gains tax while selling a property.

Things to Keep in Mind Regarding Capital Gains Tax on the Sale of Property

There are several things that you must keep in mind regarding capital gains tax on the sale of property:

• Sellers can claim for exemption on capital gains even if they have not received possession of the property.
• Individuals must ensure that the value of the property that they register must not under the price specified by the Government.
• Depending on the holding period of the property, the profit on the transaction will be treated as Short Term Capital Gains or Long Term Capital Gains and taxed accordingly. If you sell a property within two years of the purchase, the gains you earn would be treated as STCG and will be taxed, depending on your tax slab.
• If sellers do not wish to invest their capital gains in property or bonds, they can invest them in the Capital  Gains Account Scheme to qualify for tax exemption. If taxpayers do not invest their entire capital gain in a specified investment asset before the stipulated time limit expires for that investment and before the due date of filing income tax returns, then they can invest the remaining balance in the Capital  Gains Account Scheme. Any capital gain invested in Capital Gains Account Scheme will be eligible for capital gain exemption as it would in case of re-investment.

Final Word

It is essential to know how to save capital gains tax on the sale of residential property under Section 54. This way, home buyers can reap immense benefits by obtaining substantial exemptions. Additionally, it is also important to keep the criteria in mind to timely claim an exemption on taxes.

FAQs about Tax savin on the Sale of Real Estate Property