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Capital Gains either short term or Long term is subject to tax at their respective tax rate. And in order to provide relief to the taxpayers Income tax Act provides various Exemptions or deductions.

Here we are going to discuss one of such exemption i.e., Section 54. Under this section, a seller of residential house is allowed to to take exemption if he/she acquires or constructs a another residential property from the profit on sale.

ELIGIBLE ASSESSEES – Only Individual and HUF is eligible for exemption

CONDITIONS TO BE FULFILLED

  • There should be a transfer of residential house (buildings or lands appurtenant thereto )
  • Transferred asset must be long term ( period of holding>24 months )
  • Income from such house property should be chargeable under head House Property

Where the amount of capital gains exceeds ₹ 2 crore – one residential house in India should be

  • purchased within 1 year before or 2 years after the date of transfer or
  • constructed within 3 years after the date of transfer.

Where the amount of capital gains does not exceed ₹ 2 crore – the assessee may at his option

  • purchase two residential house in India within 1 year before or 2 year after the date of transfer or
  • construct two residential house in India within 3 years after the date of transfer.

Capital Gains Exemption on Sale of Residential House under Section 54 of Income Tax Act

If during any assessment year , the assessee has exercised the option to purchase or construct two residential house in India, he shall not be subsequently entitled to exercise the option for the same or any other assessment year.

This implies that if an assessee has availed the option of claiming exemption of section 54 in respect of purchase of residential houses in Bhopal or Indore, say, in respect of capital gains of ₹1 .50 crores arising from transfer of residential house at Delhi in the P.Y. 2023-24, then he will not be entitled to avail the benefit of section 54 again in respect of purchase of two residential gains in Kolkata and Goa in respect of capital gains of ₹ 1.20 crores arising from transfer of residential house in Bombay in the P.Y. 2026-27,even though the capital gains arising from transfer does not exceed ₹ 2 crores.

  • If such investment is not made before the date of filing of return of Income then, capital gain has to be deposited under the Capital Gains Account Scheme (CGAS ). However, the capital gain in excess of ₹ 10crore would not be taken into account for the purpose of deposit in CGAS.
Popular case law – B.B. Sarkar vs Commissioner Of Income Tax ( CALCUTTA HC )
  • Amount utilized for purchase or construction of new asset and amount so deposited shall be deemed to be the cost of new asset.

For the purpose of exemption under section 54 the cost of new asset is restricted to ₹10 crores.

QUANTUM OF EXEMPTION

  • If the cost of new residential house >= long term capital gains, entire gains is exempt
  • if cost is < long term capital gains, then upto to the extent of cost of new residential house is exempt.

With effect from 2024-25, the Finance Act 2023 has restricted the maximum exemption amount under section 54to ₹10 crore

amount exceeding 10 crore shall be ignored.

EXAMPLES

1. If the long term capital gain is ₹2 crore and cost of new house is ₹ 3 crore then entire capital gains of ₹2 crore is exempt.

2. If the long term capital gain is ₹2 crore and cost of new house is ₹1.5 crore then capital gain is exempt upto ₹1.5 crore.

Balance ₹50lakh is taxable @20%.

CONSEQUENCES OF TRANSFER OF NEW ASSET BEFORE 3 YEARS

  • Where the new asset is transferred before 3 years from the date of acquisition or construction then cost of asset will be reduced by capital gains exempted for computing capital gains.

Example- Suppose long term capital gain is ₹2 crore and cost of new house is ₹3 crore, entire capital gain of 2 crore will be exempt.

if the new house is transferred before 3 years (say 12 month) for ₹4 crore then short term capital gain would be –

Description Amount
Net Consideration ₹4 crore
less: Cost of acquisition – capital gains exempt earlier ₹1 crore
(₹3 crore – ₹2 crore)
Short term capital gain chargeable to tax ₹3 crore

Conclusion: Section 54 of the Income Tax Act provides significant relief to taxpayers by exempting capital gains from the sale of a residential house, provided the gains are reinvested in another residential property. By understanding and fulfilling the necessary conditions, eligible assessees can optimize their tax liabilities effectively. The recent amendments and examples highlight the practical application of this provision, ensuring that taxpayers are well-informed to make the best decisions regarding their investments.

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