Section 54 of Income Tax Act: Capital gains exemption rules

The Budget 2023-24 has capped the deduction from capital gains on investment in residential house under Sections 54 and Section 54F at at Rs 10 crore for better targeting of tax concessions and exemptions.  In this guide, we will understand the implications the changes made to Section 54, and how it will affect property sellers.

 

See also: 269ss of income tax act

What is Section 54 of income tax?

Earning of any profit is treated as income and taxed under various provisions of the income tax law in India. The same is true for sale proceeds earned from the sale of a property. Based on the holding period of the property, a seller is liable to pay capital gains tax – either long-term capital gains (LTCG) or short-term capital gains (STCG).

However, to ensure benefits for owners who sell their existing property to purchase a new one to live in and not for making money through the same, the income tax law allows tax deductions under Section 54 and Section 54F.

See also: 206cr of income tax act

 

Section 54: Key Facts

 

Seller category

Deductions under Section 54 are offered only to individuals and Hindu undivided families. Companies, businesses and other entities cannot apply for this benefit.

All about: sec 56 2 x of income tax act

Type of property

The deduction is only applicable when a residential property is sold and the gains are invested in another residential property. The sale and purchase of any other type of property – commercial, agricultural or industrial – are not covered under Section 54.

Applicability on long-term capital gains

To claim deductions under Section 54, you must hold the property for a long term. The income tax law defines 24 months or 2 years as ‘long term’. If the property is sold within this period, the gain would be treated as short-term capital gain and exemption under Section 54 will not be applicable.

 

Number of properties

As per the amendment made to Section 54 through the Finance Act 2020, a taxpayer can claim deductions under this provision on the investment made in two residential properties. The exemption on investment in the purchase or construction of two residential properties is available, if the amount of the LTCG does not exceed Rs 2 crore. Note that this option can be exercised only once.

Know about: Section 142(1)

Construction status of property

Section 54 benefits are applicable, irrespective of whether the new property is under-construction or ready-to-move-in.

 

New investment timeline

A timeline has been set for the new purchase to claim Section 54 deduction.

 

Timeline for ready-to-move-in property

The investment in the new property must be made within two years of the sale of the previous home. In case the new home is bought before the sale of the old house, you can still claim deductions under Section 54, if the purchase was made not more than a year before the sale. Suppose you sold the old house in January 2021 and bought the new house in January 2020, you will be able to claim Section 54 deductions, as long as you fulfil the other conditions.

Timeline for under-construction/self-constructed property

An under-construction property must be completed within three years of the sale of the old house. Section 54 deduction can be claimed even if you booked a new home or started the construction before the sale of the old home.

 

Latest Update: Investment cut-off date extended till March 31, 2023

In a circular issued on January 6, 2023, the Central Board of Direct Taxes (CBDT) has extended the deadline for making these investments. According to the notification, for investments that had to be made between April 1, 2021, and February 28, 2022, the deadline is now extended to March 31, 2023.

 

Location of the new property

The new property must be purchased in India only with the sale proceeds. Deductions under Section 54 cannot be claimed for a property purchased/built outside India.

 

What is the amount of capital gain exemption available under section 54?

Exemption under Section 54 would be lower of the following:

• Amount of capital gains arising on transfer of residential house, or;
• Amount invested in purchase/construction of a new residential property, including the amount deposited in the Capital Gains Deposit Account Scheme.

For better targeting of tax concessions and exemptions, deduction from capital gains on investment in residential house has been capped at Rs 10 crore in the Budget 2023-24.

 

Section 54 applicability on land, multiple plots and apartments

 

Deduction applicable on land

Deduction under Section 54 is applicable even if the newly acquired property is described as ‘land’ in the sale deed, the Delhi Income Tax Appellate Tribunal ruled in May 2022.

 

 

Deduction available on multiple plots forming one home

As mentioned already, Section 54 allows fresh investment in a ‘residential property’ for the taxpayer to claim deductions. Residential properties can be described as homes in the form of flats and apartments.

However, based on a recent judgment of the Delhi Income Tax Appellate Tribunal, Section 54 deduction can be claimed even if you buy multiple plots to build a single house. The same is true, even if the contiguous land is bought by creating and registering multiple sale deeds to build a single home. However, these plots must be next to each other and the property being developed must be within one compound. This rule must be diligently followed to claim deductions under Section 54.

 

Deduction available on multiple flats/apartments forming one home

Deduction under Section 54 is also applicable if you purchase more than one flat or apartment to construct a single unit.

 

Deduction available on independent floors forming one home

Section 54 deduction would apply if you use one or multiple independent floors of a single plot to form a single residential unit.

 

Note: In either scenario, the taxpayer will be responsible to prove that the flats/plots/independent floors form part of one single unit. Any failure to do so would repudiate them from the benefit under Section 54. In case of any delineations in the property, tax authorities may refuse to extend the benefit to the maximum extent.

 

Date of possession of new house

Irrespective of the property type, under-construction or ready-to-move-in, deductions under Section 54 is reckoned from the date of possession of the new residential house.

See also: How to save capital gains tax on sale of residential property?

Capital Gain Deposit Account Scheme

 

Suppose you sold your old home and are still looking for a new one. However, it is time to pay your income tax. In such a scenario, the benefit of Section 54 can be availed of, by depositing the unutilised amount in the Capital Gains Deposit Account Scheme in any branch of a public sector bank, following Capital Gains Deposit Accounts Scheme, 1988.

The new house can be purchased or built by withdrawing the amount from this account within the specified time limit of two or three years, as applicable.

 

 

Latest updates on Section 54

 

Sale proceeds from agricultural land not taxable as capital gains: ITAT

May 23, 203: Money received from the sale of agricultural land can’t be treated as capital gains, the Chennai Bench of the Income Tax Appellate Tribunal (ITAT) has ruled recently. If an agricultural operation does not result in generation of surplus that cannot be a ground to say that the land was not agricultural land, the ITAT said in its order.

Read full coverage here.

 

 

Section 54(F) applicable to purchase of undivided share of land: ITAT

 

The capital gains exemption under Section 54F is allowed on purchase of undivided share of land, the Chennai bench of the Income Tax Appellate Tribunal (ITAT) has ruled.

The order of the tribunal concerns a matter in which the assessee had bought land from his wife through a settlement deed in 2011 and sold part of the vacant land. The gains made through the sale were invested for purchase of a new house property purchased from the wife. The assessee claimed tax deductions under Section 54F of the income tax against this investment. The assessing officer denied the claim, saying the taxpayer was not eligible for such an exemption.

 

 

ITAT allows 50% capital gains exemption under Section 54 to joint owner

January 17, 2023: The Delhi Bench of the Income Tax Appellate Tribunal (ITAT ) has allowed 50% as capital gain exemption under Section 54 to a joint owner of property.

The case concerns one Mumtaz Naseem Syed, who filed return declaring income of Rs 3,69,340 even though she received Rs 1 crore on September 9, 2013 in the joint account held by the her and her son on property sale.  They later purchased a flat and the payment was made from the joint account.

The case was later selected for limited scrutiny for the ‘large long-term capital loss on property, sale consideration of property in ITR is less than sale consideration reported in Form 26QB and large deduction claimed under Section 54B, 54C, 54D, 54G, 54GA’. Even though Syed has no source of income, the AO found that both the assessee and her son had together invested in the house property and the deduction claimed under Section 54 by Syed should be restricted to 50%.

Accordingly, a notice under Section 143(2) and 142(1) of the Act were issued and served to the assessee. After the assessment proceedings, an assessment order was passed in 2016. The oder restricted the claim made by Syed under Section 54 to Rs 1,79,23,884 as against Rs 3,58,47,768. In addition, Rs 74,49,302 was added to her income by computing the income at Rs 78,18,640 as against Rs 3,69,340. Aggrieved by the assessment order, Syed made an appeal before the CIT(A), which upheld the addition made by the AO and confirmed the assessment order.

“Since the assessee and her son have jointly invested the house property and are the joint owners of the house property having 50%
right, title and interest over the property, the Assessing Officer is, therefore, correct in restricting the claim of the assessee under Section 54 to Rs 1,79,23,884 by making an addition of Rs 74,49,302/ to the total income of the assessee,” the ITAT said in its order.

 

FAQs

What is Section 54 tax exemption?

Exemption under Section 54 can be claimed in respect of capital gains arising on transfer of a capital asset, ‘being long-term residential house property’.

Who can claim Section 54 benefits?

This benefit is available only to an individual or HUF.

What is the timeline to buy a new property to claim the Section 54 exemption?

To claim an exemption under Section 54, the taxpayer must purchase another house within one year before or two years after the date of sale of an old house or should construct another house within three years from the date of transfer.