This article is written by Jaya Vats, a practising advocate in Delhi. In this article, the author provides a detailed study of Section 54 of the Income Tax Act. The article provides an in-depth analysis of the purpose, applicability, and exemptions of Section 54.

This article has been published by Sneha Mahawar.​​ 

Introduction

On several occasions, homeowners have to sell their homes due to circumstances such as relocating to a different place, changing careers, retiring, and so on. If the seller of a residential property purchases or develops another residential property from that amount, he or she receives capital gains tax advantages under Section 54 of the Income Tax Act, 1961. In other words, if an assessee sells a residential property and then buys or builds another residential property, he/she is free from capital gains tax under Section 54 of the Income Tax Act. 

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Section 54 of the Income Tax Act

House owners may need to sell their property for a variety of reasons, such as relocating to a new location, changing employment, retiring, and so on. Property is frequently bought and sold for investment purposes. Property owners, on average, make a profit on the sale of their properties. This is particularly true if the owner has been in possession of the property for a long period. According to Indian tax rules, the profit gained in this manner is considered a source of income for which the income earner is required to pay taxes.

Section 54 of the Income Tax Act exempts the seller of residential property from capital gains tax. The clause permits taxpayers to get capital gains tax reduction only if the funds of the sale are utilised to purchase another residential property. Owners of residential properties frequently sell their property in order to buy another one, due to varied reasons such as, for a variety of reasons such as job relocation, retirement, and so on. In such a circumstance, a taxpayer sells a property not for the sake of profit, but for the purpose of relocating. As a result, when a taxpayer sells a residential property and buys another, the taxpayer is free from capital gains under Section 54 of the Income Tax Act.

Applicability of Section 54 of the Income Tax Act

Section 54 entitles a person to avail an exemption when he sells a residential property and buys a new one under specific conditions. The assessee must develop or acquire a home property for his personal dwelling in order to benefit from Section 54. The Section’s phrasing would indicate that the legislation does not require that the selling consideration acquired by the assessee itself be used to purchase real estate. The primary portion of Section 54 states that the assessee must acquire a home property for the purpose of his own habitation within one year before or after the date on which his property was transferred, or he must construct a house property within two years from the date of transfer. 

Eligibility criteria to avail benefits under Section 54 of the Income Tax Act

According to this Section, an assessee is qualified to claim a tax exemption when he or she sells a residential property that is a long-term capital asset and purchases another residential home property. 

Individuals must meet the following requirements to qualify for this exemption:

  • They should either be an individual entity or a HUF. (This provision does not assist the businesses)
  • The taxpayer’s house property should be a long-term capital asset.
  • The property to be sold should be a single-family home. This property’s revenue should be charged under the heading ‘income from dwelling property’.
  • The new residential home property shall be acquired one year before the transfer date or two years after the transfer date. In the event of a new house building, the individual is allowed an extended time frame to construct a house, namely within three years of the date of transfer or sale.
  • The residential property purchased should be within the territory of India.

If the individual fails to meet any of the above-mentioned qualifications, he/she will not be eligible to claim an exemption under Section 54 of the Income Tax Act. A taxpayer may claim a benefit under Section 54 of the Income Tax Act for just one residential home property acquired or built-in India. If a taxpayer is involved in more than one such transaction over the taxpayer’s lifetime, the benefit will be accessible for just one of the transactions. Finally, a taxpayer cannot sell a house in India and acquire a residence elsewhere while getting Section 54 benefits. The property must be acquired or built-in India exclusively.

Purpose of Section 54 of the Income Tax Act

A person can invest in a property today, hold it for a few years, and then sell it off for a better price. This is an age-old adage for many people who choose lower-risk, safer, and less volatile investments. However, when individuals construct their plans, the most important aspect of tax planning is sometimes overlooked. Individuals can arrange a sale of immovable property and reinvestment with the necessary preparation for tax exemption under Section 54.

An individual must comprehend if the amount of his or her income is taxed on the sale of the property. Profit from the sale of a property is individually taxed. Profit is calculated as the difference between the property’s sale price and the asset’s cost.

Exemptions under Section 54 of the Income Tax Act

According to Section 54 of the Income Tax Act, any person or HUF who sells a residential property can claim tax exemptions on capital gains if the capital earnings are used to purchase or construct a residential property.

Companies, LLPs, partnership businesses, and other bodies or associations cannot claim any type of tax exemption under Section 54 of the Income Tax Act. The following are the requirements that must be met in order to take advantage of this Section:

  • The asset must be considered a long-term capital asset, i.e. any capital asset held by a person for a period of more than 36 months immediately preceding the date of its transfer.
  • If the asset sold is a residential property, the income created from such a house should be taxed in accordance with the revenue earned from House Property.
  • The property seller must have bought a residence within two years of the date of transfer/sale or within one year of the date of transfer/sale.
  • The residential residence must be located in India. The seller is not permitted to acquire any residential property outside of India and claims this exemption.

All of the requirements listed above are cumulative. As a result, even if one of the aforementioned qualifications is not met, the seller will be ineligible to benefit from the Section 54 exception.

The Finance Act, 2020, modified Section 54 with effect from Assessment Year 2021-22 to prolong the advantage of the exemption in respect of investment in two residential house properties. The exemption will be provided for investments made in two residential home properties through acquisition or building if the amount of long-term capital gains do not exceed Rs. 2 Crores. If an assessee exercises this option, he will not be able to do so again for the same or any subsequent assessment year.

Exemption amount

Section 54 of the Income Tax Act provides for a capital gains exemption equal to the lesser of:

  • Amount of capital gains realised on the sale of a residential property.
  • Investing in the acquisition or building of a new residential residence.

The deduction on capital gains permitted would be revoked if the taxpayer transferred the new asset three years from the date of acquisition.

Capital gains

Capital gains are profits made from the sale of an asset. Gains in the stock market are obtained from the difference in value between a stock’s buy and sell price. When you sell an asset for less than what you purchased for it, you incur a capital loss. Because the gain or profit is defined as “income” under Indian income tax regulations, the individual who earns from the sale is required to pay tax on the profit amount during the year in which the capital asset was transferred.

The sale of a residential residence is a sale of an asset, and the profit generated from the sale is referred to as a capital gain. Section 2(14) of the Income Tax Act defines a capital asset as “any property of any kind, whether immovable or moveable, intangible or tangible, held by the assessee for any particular purpose.”

According to the Income Tax Act, capital gains are categorised into two classes based on the asset’s holding term, which are as follows:

  • Short-term capital assets: These are owned by a single person for a duration of less than 36 months. The earnings gained from the sale of these assets are referred to as short-term capital gains.
  • Long-term capital asset: Long-term capital assets are those held by the assessee for more than 36 months. The earnings gained from the sale of these assets are referred to as long-term capital gains.

To be deemed a long-term capital asset under Section 54, the home property must be kept for more than 24 months.

One of the main factors for claiming Section 54 benefits is that the residential property is a long-term capital asset. As a result, in order to claim capital gains exemption, the taxpayer must have kept the property for more than three years from the date of purchase.

Capital Gains Account Scheme

A taxpayer with long-term capital gains from the sale of a residential property might avoid the same under Section 54 of the Income Tax Act by acquiring or building a residential property one year before or two years after (in the event of property acquisition) or before three years (in case of construction of property). In certain situations, the taxpayer would not have invested the funds from the sale of the residential property at the time of filing income tax returns. In such instances, the capital gains advantage under Section 54 can be obtained by depositing the unutilised sum in the Capital Gains Account Scheme at any public sector bank branch.

Deposits made through the Capital Gains Account Scheme are subject to numerous restrictions outlined in the Income Tax Act:

  • This is done in an approved bank branch by the government. Bank branches in remote regions are not featured.
  • To avoid fines, the deposition must be finished by the filing deadline for income tax returns.
  • Deposited funds must be utilised to purchase or build a property, according to the law.

It is crucial to remember that if the sum invested in the Capital Gains Account Scheme is not used within the prescribed time frame, it will be recognised as income for the previous year (from the date of transfer of the original asset).

Non-utilisation of funds put in the Capital Gains Account Scheme

If the amount placed in the Capital Gains Account Scheme for which the taxpayer has claimed exemption under Section 54 is not used for the purchase/construction of a residential dwelling within the required time, the unutilised amount (for which exemption is claimed) shall be taxed as income by means of long-term capital gains in the year in which the stated period of 2 years/3 years expires.

Section 54F of the Income Tax Act

Section 54F of the Income Tax Act of 1961 provides for tax exemption on long-term capital gains realised from the sale of a capital asset other than a residential property. So, if a person sells a capital asset such as shares, bonds, jewellery, gold, and so on and reinvests the profits in the acquisition or building of the home property, the returns received on the sale of capital assets are tax-free under Section 54F.

Section 54F of the Income Tax Act exempts capital gains from taxation when long-term capital assets are transferred in exchange for an investment in a residential dwelling. The following are the key elements for obtaining exemption under Section 54F:

  1. Individuals and HUFs are the only ones who qualify for the exemption under Section 54F.
  2. The capital gain should have resulted from the transfer of any long-term capital assets other than a residence.
  3. The net consideration generated by the transfer of long-term capital assets should have been invested as follows:
  • Within one year before the transfer date or within two years after the transfer date, the net consideration was re-invested in the acquisition of one residential dwelling; or
  • Within 3 years of the transfer, the net consideration was re-invested in the construction of one residential house in India.

Exemption under Section 54F is not available in the following circumstances:

The following are the situations in which an exemption is not possible under Section 54F of the Income Tax Act of 1961:

  1. As of the date of transfer of the original assets, the assessee owned more than one residential home property. However, residential home property purchased for the purpose of claiming exemption under Section 54F is free from the same.
  2. The assessee purchases a second residential dwelling within one year after the transfer of the first asset. The new asset bought for the purpose of claiming exemption under Section 54F is exempt from this provision.
  3. The assessee builds an additional residential dwelling within three years of transferring the original asset. The new asset built for the purpose of claiming exemption under Section 54F is exempt from the same.

Deduction amount

If the entire net consideration is deposited in the acquisition or building of a residential dwelling, the entire long-term capital gain is excluded under Section 54F. Only the proportionate amount of long-term capital gain is exempted under Section 54F if only a portion of the net consideration is invested in the purchase/construction of a residential dwelling. The following formula can be used to get the proportionate amount of exemption –

Exemption under Section 54F = Long-term capital gains x Amount reinvested/Net Consideration

Difference between Section 54 and 54F of the Income Tax Act

Although Section 54 and Section 54F has some similarities, these are slightly different as well. Section 54 as a whole allows for tax exemption on long-term capital gains realised from the sale of capital assets. The section, however, is separated into Sections 54 and 54F. The primary distinction between these two categories is the sort of capital asset sold. Section 54 allows for a tax exemption on long-term capital gains if you sell a home or dwelling property. However, the long-term capital gain on any other capital asset, other than property, is free from taxation under Section 54F of the Income Tax Act. Here are other differences-

  • Section 54 of the Income Tax Act exemption is applicable only when you sell a residential property. On the other hand, Section 54F of the Income Tax Act exemption is available in any capital asset transfer other than a residential property.
  • Section 54 exemption is applicable only if the long-term capital gain is invested in constructing or purchasing one residential property. On the other hand, according to Section 54F of the Income Tax Act, a taxpayer can invest in two residential properties only once in a lifetime provided only if the long-term capital gain is within 2 Crores. In Section 54F, Section 54F of capital gain needs to be used for constructing or buying any residential property. Section 54F of the capital gain must be used for the construction or purchase of any residential property.
  • Section 54 does not require you to restrict the number of residential homes you possess. However, Section 54F of the Income Tax Act exemption does not apply if the taxpayer owns more than one residential property on the day the long-term asset is transferred.
  • Even after claiming an exemption under Section 54 a person is eligible to purchase any other residential property. Such a person however cannot purchase another residential property if you have sought the exemption under Section 54F of the Income Tax Act.

Significant case laws

Ms. Moturi Lakshmi vs. The Income Tax Officer, 2020 

Facts of the case

The taxpayer put a down payment on a new apartment before selling her old one, and she sought an exemption under Section 54 for the amount. Because the investment was made prior to the sale of the first unit, the Assessing Officer (AO) denied the exemption. The Commissioner of Income-tax and the Income-tax Appellate Tribunal (ITAT) both dismissed the taxpayer’s subsequent appeals and affirmed the AO’s decision. The taxpayer filed an appeal with the Madras High Court against the ITAT’s decision.

Issues involved in the case

The High Court stated that the issue under consideration raised the following important point of law: Whether an advance payment made by the taxpayer for the purchase of a residential unit, comprises a part of the purchase price for the purposes of Section 54, when the advance payment is given to the apartment seller prior to the date of sale of the original capital asset.

Judgment of the Court

The Madras High Court upheld the benefit under section 54 in relation to the taxpayer’s advance payment made for the acquisition of a residential flat prior to the date of sale of the original apartment. It went on to say that the Legislature’s objective was to buy before or after the date of sale, and the words ‘bought’ or ‘built’ used in the Notes in the Clauses, make that plain. In view of the foregoing arguments, it was determined that the significant issue of law must be resolved in favour of the assessee.

Commissioner of Income Tax vs. Gita Duggal, 2013

Facts of the case

The assessee engaged in a development agreement under which the developer destroyed the property and built a new three-story structure. The assessee got Rs. 4 Crores and two floors of the new building in exchange for giving development rights. The Assessing Officer determined that the cost of construction of Rs should be used in calculating capital gains. The developer’s development costs of Rs. 3.43 Crores were to be added to the assessee’s total receipts of Rs. 4 Crores.

Issues involved in the case

The issue before the court was that the assessee contended that because the capital gains were invested in the two floors, she was qualified for exemption under Section 54.

Judgment of the Court

The Delhi High Court opined that the phrase “a residential unit” was not utilised. The sole stipulation is that it be used only for household purposes and not for commercial purposes. If nothing in the provision demands that the residential house be erected in a specific manner, it appears that the income-tax authorities cannot impose such a condition. A person may build a residence according to his or her designs and specifications, thus the assessee is eligible for exemption.

Commissioner of Income Tax v. Syed Ali Adil, 2012

Facts of the case

The assessee used the capital gains from the transfer of his ancestral dwelling property to purchase two apartments. The two flats are in the same apartment, with neighbouring kitchens and toilets, and they share a common meeting spot. Section 54 utilises the word “a residential property” to refer to the new asset.

Issues involved in the case

The main issue before the court was that the department contended that the section’s text assumes a circumstance in which a single residential property (new asset) is acquired through the transfer of an old asset and the assessor cannot subsequently invest the capital gains in two flats.

Judgment of the Court

The Andhra High Court held that the word “a residential property” encompasses more than one residential property, and hence the assessee was entitled to a deduction under Section 54.

Ishwar Singh Chawla v. Commissioner Of Income Tax, Mumbai, 2009

Facts of the case

The assessee, an individual, earns money via real estate, business, long-term capital gains, and other sources. During the course of the assessment, the Assessing Officer (AO) saw that the assessee had reported a different sum as a taxable capital gain on the sale of the apartment and plot. The AO further noted that the assessee had purchased a new residential residence with a loan from Punjab National Bank (PNB). However, the funds received on the property transfer were not used to pay off the loan liability obtained for acquiring the new residential house because the loan with PNB was still outstanding in the subsequent years and the assessee was claiming interest on borrowed funds as a deduction from his income.

Issues involved in the case

The issue before the court was whether Section 54 is necessary in relation to drawing a nexus between capital gain and the amount of investment.

Judgment of the Court

The Income Tax Appellate Tribunal, Mumbai ruled that the provision under section 54 does not require an assessee to demonstrate a link between the amount of capital gain and the cost of a new asset. It was determined that the assessee had originally invested the profits of the sale of its residential apartment in commercial properties before purchasing two residential flats within the time limit required in sub-section (2) of Section 54. The major point of contention was that the sale earnings were used to acquire a commercial property, while the residential dwelling was purchased using monies collected from other sources; as a result, the identification of the heads has been altered.

Commissioner Of Income Tax v. Ravinder Kumar Arora, 2011

Facts of the case

The assessee filed his return for the Assessment Year 2007-08, revealing a total income of Rs. 64,32,220/-. The Assessing officer noted in the assessment proceedings that the assessee is the proprietor of M/s. Arora Service Station operates a fuel pump, and during the relevant year, the assessee had a long-term capital gain of Rs. 45,49,045/-. The Assessing officer discovered that the purchase deed for the aforementioned residential dwelling was made jointly in the names of the assessee and his wife while reviewing the purchase deed. The assessee claimed exemption under Section 54F of the Act for the whole amount spent on the aforementioned home property. The assessee sold land he held and claimed capital gain exemption under Section 54F for the purchase of a new dwelling. The Assessing Officer determined that the assessee was only entitled to the exemption claimed under section 54F to the extent of his right in the new residential dwelling acquired jointly with his wife, granting only 50% of the exemption claimed under section 54F as a percentage of the total claim.

Issues involved in the case

In the case of a house registered in joint names, whether the exemption under Section 54F can be granted fully to the co-owner who has paid the entire purchase price of the house property, or will it be limited to his share of the house property?

Judgment of the Court

The Delhi High Court ruled that the assessee was the true owner of the residential property in dispute and that just including his wife’s name in the sale document made no difference. The court further noted that while Section 54F requires that the house be acquired by the assessee, it does not require that the house be purchased solely in the assessee’s name. As a result, the requirements required in Section 54F are met, and the assessee is entitled to the whole exemption sought in respect of the purchase price of the home property.

Conclusion

The benefits of exemption on the sale of residential property are explained in Section 54 of the Income Tax Act. This section allows for tax breaks on long-term capital gains from the sale of a residential property. This benefit can be claimed by either purchasing/constructing a new residential property or putting the number of sale profits in any authorised/approved bank’s Capital Gains Account Scheme.

FAQs

What is the maximum exemption amount allowed under Section 54?

The amount invested in a new home or the capital gain, whichever is less.

Is it possible to avail the advantage of both the sections namely, Section 54 and 54F?

Section 54F advantages may be obtained if a person sells assets other than house property and subsequently invests the proceeds in any home property. Section 54, on the other hand, permits an individual to receive an exemption while selling a dwelling property. As a result, neither can be used.

Is Section 54F applicable to non-resident Indians?

Yes, NRIs can take advantage of Section 54F privileges as well. To qualify for the exemption, however, all conditions must be satisfied.

How many residential dwelling properties can be bought/built?

Only one house property may be acquired or built for the purpose of claiming an exemption under Section 54.

References

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