Capital Gain Tax Exemption on Property under Redevelopment

1. Redeveloping old buildings and societies is gaining momentum in major cities like Mumbai, Delhi-NCR, Surat, Bengaluru etc. Mumbai, India’s financial capital, is leading this trend.

1.1 Redevelopment is a complex process, and one of the biggest challenges faced by taxpayers is to ascertain the tax implications of the redevelopment of their property. The residents of the old building get larger apartments in the newer building for free. Tax implications on receipt of such larger apartments or exemptions on the sale of said flats are confusing for many.

2. In this article, an attempt has been made to simplify the Capital Gain Tax implication on such issues, with the help of Illustrations.

2.1 Illustration 1: Mr. Ajit had an MHADA apartment which he purchased in 1996. The building went under redevelopment in 2019, and he got possession of a new flat in 2022. He is really confused about tax implications at the time of handing over the apartment for redevelopment. The second question in his mind is whether he is eligible for exemption under section 54 on getting a new flat in the redeveloped building.

2.2 The first event of capital gains taxation will occur on the surrender of the flat to the builder for redevelopment. However, he is eligible for Capital Gain Exemption under section 54 and the Net Tax Liability will be NIL.

3. Relevant Provisions: Section 54 of the Income Tax Act states that if any residential property which was held for more than 3 years is sold or given for redevelopment and the new flat is purchased or acquired within 1 year before or 2 years after the sale or constructed within 3 years after the sale then capital gain arising on the transfer of the old flat will be exempt to tax under the said section to the extent of the cost of such new flat.

3.1 Explanation: The said property was held by Mr. Ajit for more than 3 years (from 1996 to 2019). It was surrendered for renovation in 2019, and he got possession of a new flat in 2022.

3.2  In the case of redevelopment, the new flat to be acquired is treated as “constructed” for Section 54. Thus, if the new flat is acquired by the owner within 3 years from the surrender of the original flat then the capital gain arising from the sale of the original flat can be claimed to be exempted u/ s. 54 of the Income Tax Act.

3.3 Since Mr. Ajit acquired the new flat within 3 years from the surrender of the original flat, the capital gain tax implication will be NIL as he is eligible for exemption under section 54 of the Act.

4. What if the builder failed to hand over the possession of the new flat within the stipulated period of three years?

4.1 If the new flat is not acquired by the owner within 3 years, then the Assessing Officer at his discretion can disallow the same at any time during the assessment.

4.2 The assessee shall be entitled to claim exemption in respect of capital gains even though the construction is not completed, and the builder failed to hand over the possession within the stipulated period. Provided that, the redevelopment agreement has to have a clause that the builder will hand over the possession within three years)

5. Capital Gain Tax on sale of redeveloped property: In case the redeveloped property is sold within 2 years from the date of possession, the resultant gains would be taxable as Short-Term Capital Gain Tax.

5.1 Illustration 2: Mr. Sanjay was a tenant in a building and the said building has gone under redevelopment. He got possession of a flat in the redeveloped building and signed the PAA (Permanent Allotment of Apartment) agreement in 2023. Mr. Sanjay wishes to sell the flat in 2024. What will be the Capital Gain Tax

5.2  The Capital Gain would be taxable as short-term capital gains (STCG) and taxable at the normal rates of tax applicable to him in the year of sale i.e. 2024.

5.3 The cost of acquisition in such a case would be the value at the time of completion of the redeveloped property. In other words, the cost of this property would be the sales consideration offered to tax at the time of receiving the completion certificate from the competent authorities.

6. Illustration 3: Mr. Prasanna got a residential flat in a tower after the redevelopment of his building in the year 2020.  Now, he wishes to sell his flat in 2024. The sale consideration of the said flat would be Rs 1.5 crores. What amount should he take as the cost of the flat for capital gain computation?

6.1 The capital gain on the sale of the redeveloped flat gain would be taxable as a long-term gain. For computing Capital Gain on the sale of the flat, the cost of acquisition will be the market value of the flat on the date on which he got possession in 2020.  He can obtain a valuation report from a registered valuer. Alternatively, the cost of acquisition can be ascertained as the stamp duty value of the flat plus registration charges paid.

6.2 The aggregate of fair market value, stamp duty & registration charges as indexed and reduced from the sale consideration is taxable long-term capital gains from the sale of the present flat.

7. Conclusions: Many more issues need clarity regarding tax implications on the redevelopment of property. It is advisable to consult professionals and get suitable advice to avoid probable tax liability and litigation on sale of redeveloped property.

Disclaimer: The article is for educational purposes only.

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