Exemption under Section 54 of Income Tax Act, 1961

1. WHAT IS SECTION 54?

As we all know that on selling or transferring a capital asset like property, capital gains arise which are taxable in the hands of the assessee/ taxpayer. Under Section 54 of the Income Tax Act, an individual or HUF selling a residential house property can claim exemption from such capital gains if they invest the proceeds in acquisition i.e., purchase or construction of another residential property.

2. WHAT IS A CAPITAL ASSET?

As Per Section 2(14) of the Income Tax Act, Capital Asset includes property of any kind movable or immovable, tangible or intangible held by the assessee for any purpose. It may or may not be connected to business or profession.

3. WHAT ARE THE DIFFERENT KIND OF ASSETS UNDER INCOME TAX ACT?

For Capital Gains, the assets are bifurcated into two major sections that are:

Short term capital assets: – Capital assets which are held by the individual for not more than 36 months are called short term capital assets. The gain from the sale of these assets are called short term capital gains.

Long term capital assets: – Capital assets that are held by the assessee for more than 36 months are called long term capital assets. The gain from selling these assets is called long term capital gains.

If unlisted shares and land or other immovable property is held for more than 24 months, it is considered as a long-term capital asset.

Following assets shall be treated as long-term capital asset

• Listed securities
• Units of Equity oriented fund
• Zero-coupon bond

For Section 54, the house property should be held for more than a period of 24 months to consider an asset as a long-term capital asset.

4. WHO IS ELIGIBLE TO TAKE THE BENEFITS UNDER SECTION 54?

Only Individuals or HUF are eligible to claim this benefit. Taxpayer’s such as Partnership Firms, LLP’s, Companies or any other Association or Body cannot reap the benefits of this section.

5. WHAT ARE THE MANDATORY CONDITIONS THAT NEEDS TO BE FULFILLED TO CLAIM THE EXEMPTION?

Asset must be classified as a Long-term capital asset.

The asset sold is a Residential House. Income from such a house should be chargeable as Income from House Property

The seller should purchase a residential house either 1 year before the date of sale/transfer or 2 years after the date of sale/transfer. In case the seller is constructing a house, the seller has an extended time, i.e. the seller will have to construct the residential house within 3 years from the date of sale/transfer. In case of compulsory acquisition, the period of acquisition or construction will be determined from the date of receipt of compensation (whether original or additional compensation)

The new residential house should be in India. The seller cannot buy or purchase a residential house abroad and claim the exemption.

Note: – The above conditions are cumulative. Hence, even if one condition is not fulfilled, then the seller cannot avail the benefit of the exemption under Section 54.

With effect from Assessment Year 2020-21 corresponding to FY 2019-20, a capital gain exemption is available for purchase of two residential houses in India. However, the exemption is subject to the capital gain not exceeding Rs 2 crore. Also, the exemption is available only once in the lifetime of the seller. 

6. HOW MUCH AMOUNT IS EXEMPTED?

The amount of exemption under Section 54 of the Income Tax Act for the long-term capital gains will be the lower of:

Long Term Capital gains arising on transfer of residential house, Or

The investment made in purchase or construction of a new residential house property. Hence, the balance capital gains (If any) will be taxable.

ILLUSTRATIONS: –

Mr Ram sells his house property and capital gain on sale amounted to Rs. 45,00,000/- in Dec 2021.

With the proceeds of the sale, he purchases another house for Rs. 20,00,000/- in March 2021.

Capital Gains will be computed as follows: –

Particulars	Amt (Rs.)
Capital gain on transfer of residential house	45,00,000.00
Less: Investment made in residential house property	20,00,000.00
Balance – Capital Gains	25,00,000.00

The exemption will be lower of the Capital Gains (Rs 45,00,000) or investment in new property (Rs 20,00,000), so the exemption will be Rs 20,00,000.

Remaining 25,00,000 will be taxable @20% in addition to surcharge & cess. 

7. WHAT ARE THE PROVISIONS RELATING TO THE TRANSFER OF PROPERTY AFTER CLAIMING BENEFIT UNDER SECTION 54?

If the new house is sold within 3 years from the date of purchase or construction, then the exemption claimed earlier under section 54 shall be indirectly taxable in the year of sale of the new house property. Let’s consider two scenarios when the new house is sold within 3 years from the date of purchase or construction:

Case 1: Cost of the new house purchased is less than the capital gains computed on the sale of the original house.

Generally, when a house is sold, the profit is considered as capital gains. However, when the new house is sold within 3 years from the date of purchase or construction, then the cost of acquisition will be considered as Nil. Hence, there will be an indirect increase in taxable capital gains. 

Example: – Mr. Kiyansh has sold residential house property in May 2019 and the capital gains amounted to Rs. 30,00,000/- In June 2019, Mr. Kiyansh purchased a residential house property worth Rs. 18,00,000/-.

Mr. Kiyansh sells the new residential house property (Purchased in June 2019) in December 2020 for Rs. 40,00,000/-

Based on the facts mentioned above, lets compute the taxable capital gains for Mr. Kiyansh for FY 19-20 & 20-21.

Solution: –

FOR FY 2019-2020: -PROPERTY SOLD IN MAY 2019: –

Particulars	Amt (Rs)
Capital gain on transfer of residential house	30,00,000.00
Less: Investment made in residential house property	18,00,000.00
Balance – Taxable Capital Gains in FY 19-20	12,00,000.00

 FOR FY 2020-21: – PROPERTY SOLD IN DEC 2020: –

Particulars	Amt (Rs)
Consideration for transfer (Sale Consideration)	35,00,000.00
Less: Cost of Acquisition	NIL
Balance – Taxable Capital Gains in FY 20-21	35,00,000.00

 Note:  As the new property for which deduction was claimed under Section 54 was sold in December 2020 (ie within 3 years from the date of acquisition), hence it’s cost of acquisition was considered as NIL.

 As a result, the entire sale consideration was considered as capital gains. Had the property been sold after 3 years, i.e., after June 2022, then in such case the cost of acquisition would be available as a deduction and capital gains would reduce.

Case 2: Cost of the new house purchased is more than the capital gains computed on the sale of the original house

If the cost of the new asset purchased is greater than the capital gains, then it is obvious that there will be no capital gains as the entire capital gains will be exempted. However, if the new house is sold within 3 years, then cost of the new house will be computed as follows:

Particulars	Amt (Rs)
Original Cost	XXXX
Less: Capital gains claimed for the earlier house property	XXXX
Cost of the new house	XXXX

Example:- Let’s understand the above case with the help of an example Mr Z has sold a residential house property and the capital gains is Rs 25,00,000/- in June 2015.

In October 2015, Mr Z purchased a new residential house property of Rs 40,00,000/- In January 2017, Mr Z sold the new residential house Property for Rs 55,00,000/-

Based on the capital gains mentioned above, let’s compute the taxable capital gains for Mr Z FY 15-16 (Property sold in June 2015). 

Particulars	Amt (Rs)
Capital gain on transfer of residential house	25,00,000.00
Less: Investment made in residential house property	40,00,000.00
Balance – Taxable Capital Gains in FY 15-16	NIL

 FY 16-17 (Property sold in January 2017)

Particulars	Amt (Rs)
Consideration for transfer (Sale Consideration)	55,00,000.00
Less: Cost of Acquisition (Refer Working Note Below)	15,00,000.00
Balance – Taxable Capital Gains in FY 16-17	40,00,000.00

Working Note 1: Computation of cost of acquisition (As the property was sold within 3 years of purchase and Section 54 was claimed)

Particulars	Amt (Rs)
Cost of Acquisition	40,00,000.00
Less: Capital gains claimed for earlier house property	25,00,000.00
Cost of the new house (to be considered)	15,00,000.00

WHAT IS CAPTITAL GAINS ACCOUNT SCHEME?

If the asset is sold in the PY, and the seller intends to, but is yet to purchase the new house property as the time limit of 2 years or 3 years has not yet expired, then the assessee is required to deposit the amount of gains in the Capital gains account scheme (in any branch of public sector, bank) before the due date for filing income tax returns.

The amount already incurred towards purchase/construction along with the amount deposited in the capital gains account scheme can be claimed as cost while claiming the deduction.

However, if the amount deposited in the Capital Gains Account Scheme is not utilized within the time limit mentioned, then it shall be treated as income of the previous year in which 3 years expire (from the date of transfer of the original asset). 

WHO PAYS THE TDS IN CASE OF SALE OF PROPERTY?

Any person (Buyer or Transferee) who enters into an agreement with a resident seller for transfer of an immovable property (land or building or both but not agricultural land) is required to deduct TDS @ 1% if sale consideration or stamp duty value (as amended by Budget 2022) is Rs. 50 lakh or more.