Section 54: Guide on Section 54 of the Income Tax Act

Section 54 of the Income Tax Act provides capital gains tax relief to sellers of residential properties. This can only be availed if taxpayers use the proceeds to buy another residential property.

Several homeowners sell their properties to buy another property for various reasons, like switching jobs, retiring, etc. Usually, taxpayers sell a house to change residence, not for gains from the sale.

Taxpayers who sell a residential property and buy another property are exempt from capital gains under Section 54.

Eligibility for Section 54 of the Income Tax Act

To claim benefits under Section 54 of the Income Tax Act, you must meet the following conditions:

  • Only an individual or Hindu Undivided Families (HUFs) can benefit from tax exemption under Section 54. No exemption is available for companies, partnership firms, and limited liability partnerships.
  • There should be a transfer of a long-term capital asset, such as the asset of a residential house.
  • You must acquire another residential house through purchase within one year before and two years after the transfer of the old house or construct a residential house within three years of the transfer of the old house, 
  • This period of two years within which the property is to be acquired or constructed will be determined based on the date of the receipt of compensation (whether or not it is the original compensation or additional compensation) in the case of compulsory acquisition.
  • Lastly, an individual who claims the benefit under Section 54 will not be able to sell a home in India and buy one abroad while claiming the benefit. The house that is purchased or constructed must be in India only.

Section 54 of the Finance Act 2020 has been amended to extend the benefit of exemption to investments in two residential houses from Assessment Year 2021-22. A tax exemption shall be available for investments made through the purchase or construction of two residential properties if their long-term capital gains do not exceed ₹2 crores.

If you exercise this option, you will not be entitled to exercise it again for the same or subsequent assessment year.

There is a cumulative effect of the above conditions. As a result, even if one of the conditions is not met, the seller cannot take advantage of the aforementioned exemption.

What is a Capital Asset?

Any property you own is considered a capital asset, whether it is related to a business or profession.

Property that is movable or immovablePlots, buildings, flats, bungalows, cottages, etc.
Intangible or tangibleVehicles, patents, trademarks, leasehold rights, etc.
Fixed or circulatingItems such as machinery, jewellery, etc.

Types of Capital Gains

According to the Income Tax Act 1961, capital assets can be divided into two categories:

  1. Short-term capital asset
  2. Long-term capital asset

Long Term vs Short Term Capital Gains

An asset held for less than 36 months is a short-term capital asset. Profits from the sale of short-term capital assets are referred to as short-term capital gains. A long-term capital asset is held for more than 36 months before it is expected to be sold. Long-term capital gains are gains derived from the sale of a long-term asset throughout its useful life.

An essential criterion for claiming benefits under Section 54 is that residential property is a capital asset that can be held for an extended period. For a property to qualify for capital gains exemption, it must have been held by the taxpayer for more than three years from the date of purchase.

Additionally, unlisted shares and other immovable property can be considered long-term capital assets if they are held for more than 24 months and not listed.

The following assets can be considered long-term capital assets:

  • Listed securities
  • Fund units with an equity orientation
  • Zero-coupon bond

House property must be held for more than 24 months for the asset to be regarded as a long-term capital asset for benefits under Section 54.

How much capital gain exemption is available under Section 54 of the Internal Revenue Code?

A taxpayer may be exempt from paying federal income taxes for the lower of the following two amounts:

  • Capital gains on the transfer of a residential property or capital gains on the sale of a residential property
  • Investments in the construction or purchase of new residential properties, referred to as new residential investments

As per the Income Tax Act, any remaining balance will be taxable.

For example:

When someone sells their house property, they earn a capital gain of ₹35,00,000. The sale proceeds were used to purchase a new house property for ₹20,00,000 with the amount received from the sale. This will result in the lower amount of ₹20,00,000 being considered exempt under Section 54 of the Income Tax Act.

The remaining balance of the two capital gains that are liable for taxation is ₹15,00,000 (35,00,000 – 20,00,000).

To qualify for exemptions under Section 54, you must fulfil several conditions, such as:

  • You must purchase new residential property or construct new residential property after selling the old house property.
  • New residential property must be purchased one year before the sale of the old property or constructed within three years following the sale or transfer of the old property.
  • A maximum of two residential house properties can be constructed or purchased per individual, provided, the total long term capital gains do not exceed ₹ 2 crores.
  • Those who fail to construct or acquire new house properties within the stipulated period may deposit the capital gains proceeds in a Capital Gains Account Scheme in any public sector bank to qualify for the exemption.

What is a Capital Gains Account Scheme?

Investing or depositing all the unutilised capital gain proceeds from the old house property in the Capital Gains Deposit Scheme is an option for assessees who cannot buy or construct property before the deadline for submitting returns of income for the year of transfer.

The proceeds of the sale of the old house can be used to purchase the new property, and the capital gains will not be taxable. The conditions specified in the Income Tax Act for deposition in a Capital Gains Account Scheme are as follows –

  • Branches of authorised or approved banks can be used for this purpose. There are no rural branches of banks included in this list.
  • The deposition must be made before the due date to file income tax returns on time.
  • It is the responsibility of the depositor to use the deposit money for the purchase or construction of the house by the law.
  • Amounts deposited in the Capital Gains Accounts Scheme are not used for any purpose other than purchase or construction of the residential property.

You should withdraw the amount deposited in the Capital Gains Deposit Scheme within three years of the transfer of the property to build a new house or buy a new property within two years of the transfer.

Capital gains would be taxed if you do not withdraw this amount within the stipulated period. As a result, you would be liable for paying tax on the capital gain on your account.

What are the consequences of transferring a new house property within three years?

After selling your old house property as a long-term capital asset, you can claim an exemption under Section 54 if you buy or construct a new house within the prescribed time frame.

Moreover, suppose you wish to sell the new property you own. As stipulated in Section 54 of the Residential Property Act, you must hold the property for a minimum of three years before selling it.

If you sell before the stipulated time, the benefit given to you will be withdrawn, and you will have to pay the tax on capital gains.

Points to keep in mind:

  • A proportionate exemption is available if the cost of the new residential property is lower than the total sale price. Invest the remaining funds within six months under Section 54EC for the remaining amount.
  • A property must only be purchased in the seller’s name and not in anyone else’s name.
  • The exemption applies if the builder does not transfer the property to the taxpayer within three years of purchase.

Frequently Asked Questions

Is the entire amount received from the sale of property taxable?

Usually, the sale consideration amount is not taxable. However, if no exemptions have been claimed, then the amount of the capital gain is taxable.

In the case of the sale of a property, who is responsible for paying the TDS?

It is mandatory for any person (buyer or transferee) who agrees with a resident seller to transfer any immovable property (land, building or both, but not agricultural land) to pay TDS at 1%. This is necessary if the sale consideration is more than ₹50 lakhs during the transaction.

When does the taxpayer benefit under Section 54?

Suppose the assessee purchases a new residential house property within one year or two years of the sale of the original house property or constructs a new house within three years of the sale of the old property. In that case, they may be eligible for the exemption.

Does Section 54 allow for a certain amount of exemption?

A capital gain from the sale of an original residential house property or a capital gain from a new residential property is entirely exempt from income tax under Section 54 of the income tax act.

Is Section 54 applicable to repair expenses?

An Income Tax Appellate Tribunal (ITAT) Mumbai judgement in October 2015 makes it possible to claim Section 54 exemptions for repair-related expenses. Moreover, it is related to the idea that a property must be ‘habitable’.
The tribunal ruled that Section 54 is an incentivising provision that must be interpreted liberally to comply with its mandate of promoting housing by providing benefits to taxpayers.

Animesh Gupta is a Chartered Accountant by profession and a NISM certified Mutual Fund Expert. He has over 4+ years of experience working in the Financial Services Industry. In his role at Wintwealth, he is part of the Credit and Risk team and evaluates the risk of the bonds available on Wintwealth's platform.

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