Capital Gain Tax Exemption – Construction of Property

1. Section 54 of the Income Tax Act prescribes that an individual selling property can avail of tax exemption if the Capital gain amount is invested in the purchase or construction of residential property. As per Section 54F of the Act, to claim exemption, the entire sale consideration needs to be invested in the purchase or construction of a residential property.

The time of investment in the construction of new residential property is given three years from the date of transfer of property. It is a common phenomenon that the construction of a house is not completed within three years of the commencement of the construction work, especially if the construction work is done by the builder. 

The question arises whether the deduction under section 54 or 54F will be available if the assessee made the payment to the builder but has not received possession within the time prescribed i.e. three years from the date of transfer.

2. This has been considered by various High Courts and ITAT Benches where they have taken a lenient view and have held that the object is to promote housing and if the assessee has invested the substantial part of the capital gain in the construction of the house in prescribed time, but construction could not be completed within the said prescribed time, the deduction u/s 54 or 54F should not be denied.

3. Let us try to understand the various scenarios with the help of Illustrations & relevant judgments. 

3.1 Illustration 1: Mr. Swaminathan sold a plot of Land on 14.05.2015. He earned LTCG (Long Term Capital Gain) which was invested in the purchase and construction of a residential house on 15.08.2015. Accordingly, a deduction under section 54F was claimed. The flat was not handed over to him till 13.05.2018. 

The commissioner (Appeals) disallowed the entire deduction stating that the construction timeline had not been met and therefore deduction under Sec 54F was not available. 

However, it was held by ITAT Delhi Branch in the case of Subramanian Swaminathan v ACIT (IT) – Delhi Tribunal 12.05.2023 that the disallowance of the exemption, merely because the construction was not completed, is without any basis and/or merit and the said action of Commissioner (Appeals) deserved to be quashed.

3.2 Illustration 2: Ms. Shakuntala sold a flat on 04.02.2022 for a consideration of Rs 1.70 crores and worked out a long-term capital gain of Rs. 1.44 crores. She entered into an agreement on 08.09.2022 for the purchase of another residential property for a total consideration of Rs 3.25 crores and paid an advance of Rs. 1.66 crores on the date of agreement i.e. 08.09.2022.

Ms. Shakuntala claimed exemption under section 54 on the ground that she had re-invested the Capital gain amount for the purchase of another residential property within the prescribed time.

The Assessing Officer disallowed the exemption stating that the purchase transaction had not been concluded as registration of the deed had not taken place and balance consideration was yet to be paid.

It was held by the High Court of Karnataka in the case of Commissioner of Income Tax Bangalore v Mrs. Shakuntala Devi that the assessee was entitled to claim a deduction since the purchase of the new property was within the prescribed period and payment made by the assessee fully covered the consideration of Capital Gain Portion.

3.3 Illustration 3: Mr. Sood sold his residential house and within four days entered into an agreement for the purchase of a residential flat and paid a certain amount to the builder. The actual possession was, however, delivered to the assessee after the prescribed date of one year and the sale deed was registered thereafter.

The Assesing Officer brought the capital gain to tax on the ground that the Assessee failed to purchase the flat within a stipulated period of one year.

It was held by the High Court of Delhi in the case of Commissioner of Income Tax v R.L Sood that the date of agreement to purchase should be taken as the date of purchase and the date of sale deed for purchase is not relevant.

It was further held by the Hon’ble Court that realizing the practical difficulty faced by the assessee in such situations, the Board issued a Circular No. 471 dated 15.10.1986 clarifying that when the DDA issues the allotment letter to an allottee under its Self- financing Scheme, on payment of first installment of cost of construction, the allottee gets title to the property and such allotment should be treated as date of construction for the purpose of Capital Gain.

On the same analogy the assessee having been allotted the flat, he having paid a substantial amount towards its cost within the stipulated period of one year, he cannot be denied the benefit of the said section because the flat purchase by him had come into his full domain within the period of one year, though the sale deed in his favour was registered subsequently.,

3.4 Illustration 4: Mr. Gopal sold certain equity shares on 20.07.2007 and invested long-term capital gain on shares in a residential house. On 28.07.2008, the builder gave an allotment letter to him which clearly mentioned that the whole price of the villa was paid by Mr. Gopal. However, the agreement for construction entered with the builder gave an outer date that went beyond the prescribed period of three years from the sale of shares.

The exemption claimed by Mr. Gopal was disallowed by Assessing Officer stating that the initial agreement of construction itself spoke of completion time being 31/12/2011 against the available time of construction by 01.08.2010.

It was held by the Hon’ble High Court of Karnataka in the case of Principal Commissioner of Income Tax Bangalore v C Gopalswamy that exemption cannot be denied merely because the agreement for construction entered by the assessee with the builder gave an outer date, which went beyond the three years from the date of sale of the shares. The assessee had done what it could do for acquiring the villa by paying the whole of the price.

It was further held by the Hon’ble Court, there is no case for the revenue that the construction itself was not started. The only grievance of the revenue is that the unit numbers have changed and the outer limit for completing the construction went beyond three years limit mentioned in Section 54F of the Act. In our opinion, none of these would disentitle the assessee from claiming the benefit u/s 54F of the Act.

3.5 Illustration 5: Mr. Uday sold certain shares and earned capital gains and within 12 months made an investment for the construction of a residential house. A registered sale deed was executed showing the transfer of property in the assessee’s favor and the assessee was in possession and occupation of said property. However, the construction activities with regard to the residential property were stopped. The flooring work, electrical work, and fitting of door shutters and window shutters were still pending.

The Assessing Officer, therefore, concluded that the construction was not completed even after a lapse of three years from the date of transfer of the shares on which capital gain was derived and disallowed the exemption claimed by Mr. Uday.

It was held by the Hon’ble High Court of Karnataka in the case of Commissioner of Income-tax v. Sambandam Udaykumar that the assessee has invested money in the construction of a residential house. The exemption cannot be denied merely because the construction was not complete in all respects and it was not in fit condition to be occupied within the period under section 54F of the Act.

3.6 Illustration 6: Mr. Rajiv sold one plot of land for a consideration of Rs. 19, 35,325/- and invested Rs. 18, 60,000 in an under-construction flat. He could not get possession of under constructed flat within the prescribed time of three years, due to the fault of the builder. A civil suit had been filed by the assessee and others against the developer/builder in this respect

The Assessing Officer rejected the claim of deduction only on the ground that the property was incomplete and a registered document was not filed by the assessee in respect to the claim of deduction under section 54F.

It was held by Mumbai Tribunal in the case of Rajeev B. Shah v. Income-tax Officer, Ward-19(2)(1), Mumbai that the exemption cannot be denied as the assessee has invested the entire sale consideration in the purchase of a residential house within the stipulated period prescribed under section 54F. It is not in the assessee’s hand to get the flat completed or to get the flat registered in his name, because it was incomplete.

It was further held by the Tribunal that the intention of the assessee is very clear to invest the entire sale consideration of land in the purchase of this residential flat. It is another issue that the flat could not be completed and the matter is pending before the Bombay High Court seeking relief by the assessee by filing suit for direction to the builder to complete the flat.

The assessee can’t complete other formalities i.e. taking over possession for getting the flat registered in his name and this cannot be the reason for denying the claim of the assessee for deduction under section 54.

Other Relevant Point : Allotment of flat or House by Co-operative Societies and other Institutions shall be treated as construction by the assessee for the purpose of section 54 and 54F: As per Circular No. 672 dated 16.12.93 and Circular No. 471 dated 15.10.1986 ,flat or house allotted under self-financing scheme of the Delhi Development Authority (DDA) or by a Co-operative Society or other Institutions, whose schemes of allotment and construction are similar to those of DDA, shall be treated as constructions by the Assessee for section 54 and 54F. For this purpose the cost of new asset is the tentative cost of construction determined by DDA and it will be immaterial that payment is allowed to be made in installments.

5. As can be seen in the above litigations & judgments thereof that the courts have tried to interpret the law liberally, in favor of the assessee but the income-tax department has steadfastly refused to see reason. The department has turned a Blind eye to the issue. In a plethora of cases, aggrieved assessees have lost section 54F exemption.

Conclusion The Capital gains exemption under section 54F is substantial. To avoid litigations and unnecessary hassles, the assessee must ensure that excessive loss is not suffered, by going for wrong construction decisions. It is advisable to take extra precautions for choosing a reputed builder and opt for housing projects approved by reputed rating companies, like CRISIL etc.

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Disclaimer: The article is for educational purposes only.

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