“Today, it takes more brains and effort to make out the income-tax form than it does to make the income.” Alfred E. Neuman
This article aims to highlight the meaning of ‘Cost of new residential house’ in the context of deduction under section 54 of Income Tax Act. To resolve the controversy of claiming deduction under section 54/54F of the Act, ‘cost of new residential property includes cost of land’.
Background– Deduction under section 54 of Income Tax Act, 1961 is allowed to individuals and HUF who sold a residential house property and bought another house property. For ready reference extract of provisions of Section 54 is enumerated below:
“54. Profit on sale of property used for residence.
Subject to the provisions of sub-section (2), where in the case of an assessee being an individual or a Hindu undivided family], the capital gain arises from the transfer of a long-term capital asset [* * *], being buildings or lands appurtenant thereto, and being a residential house, the income of which is chargeable under the head Income from house property (hereafter in this section referred to as the original asset), and the assessee has within a period of [one year before or two years after the date on which the transfer took place purchased], or has within a period of three years after that date [constructed, one residential house in India], then], instead of the capital gain being charged to income-tax as income of the previous year in which the transfer took place, it shall be dealt with in accordance with the following provisions of this section, then is to say-
(i) if the amount of the capital gain[is greater than the cost of [the residential house] so purchased or constructed (hereafter in this section referred to as the new asset)], the difference between the amount of the capital gain and the cost of the new asset shall be charged under section 45 as the income of the previous year; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be nil; or
(ii) if the amount of the capital gain is equal to or less than the cost of the new asset, the capital gain shall not be charged under section 45; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be reduced by the amount of the capital gain”.
Provided that where the amount of the capital gain does not exceed two crore rupees, the assessee may, at his option, purchase or construct two residential houses in India, and where such option has been exercised,–
(a) the provisions of this sub-section shall have effect as if for the words “one residential house in India”, the words “two residential houses in India” had been substituted;
(b) any reference in this sub-section and sub-section (2) to “new asset” shall be construed as a reference to the two residential houses in India:
Provided further that where during any assessment year, the assessee has exercised the option referred to in the first proviso, he shall not be subsequently entitled to exercise the option for the same or any other assessment year.
From the above stated provisions of Section 54 of the Income Tax Act, 1961, following are the prerequisites for claiming exemption under Section 54 of the Income Tax Act:
a. The exemption under section 54 is only available to individuals and HUF.
b. The capital asset which is transferred must be a residential house property.
c. Gain must be in the nature of Long term.
d. The seller of “residential house property “ should have either –
i. Purchased one residential house in India within a period one year before or two year after the date of transfer; or
ii. Constructed house property in India within three years of transfer.
The benefit of exemption under section 54 is also available in case of re-purchase or construction of two residential house property only and only if the amount of ‘Long Term Capital Gain’ doesn’t exceed two crores.
If the above discussed conditions are satisfied then the amount of exemption shall be lower of following:
i. Investments made towards purchase or construction of the residential house property; or
ii. Long term capital gain arising on transfer of the residential house property.
Before moving towards ‘cost of new residential house’ , a nutty question is required to be brought to the notice is that, Do the residential house can be separated from land or Can land be treated as a distinguished part, where the residential house is constructed? Nothing goes without saying that without land underneath one cannot construct/ build the house for the residential purpose. Nevertheless, the issue of computation of cost of new residential house will be clarified as under-
A plain reading of Section 54(1) makes it amply clear that capital gain is to be adjusted against the cost of a new residential house. The condition precedent for such adjustment is that the new residential house should have been purchased within one year before or two years after the transfer of the residential house, which resulted in the capital gain or alternatively, a new residential house has been constructed in India, within three years from the date of the transfer, which resulted in the capital gain. The said section does not exclude the cost of land from the cost of residential house. Thus, the key question now arises is-
Whether Cost of Land purchased within three years from the capital gain or land purchased earlier shall be includible in cost of construction is considered in exemptions under Section 54/54F?
This question of law has been taken up before the Honourable HIGH COURT OF JUDICATURE, MADRAS in the matter of C.Aryama Sundaram Vs. The Commissioner of Income Tax-3,Chennai and held that-What has to be adjusted and/or set off against the capital gain is, the cost of the residential house that is purchased or constructed. Section 54(1) of the said Act is specific and clear. It is the cost of the new residential house and not just the cost of construction of the new residential house, which is to be adjusted. The cost of the new residential house would necessarily include the cost of the land, the cost of materials used in the construction, the cost of labour and any other cost relatable to the acquisition and/or construction of the residential house.
It is reiterated that exemption of capital gain from being charged to income tax as income of the previous year is attracted when another residential house has been purchased within a period of one year before or two years after the date of transfer or has been constructed within a period of three years after the date of transfer of the residential house.
Therefore, the authorities need to follow a well settled principle of construction and interpretation of statutes that statutory provisions should, to the extent feasible, be interpreted and/or construed in accordance with plain meaning of the language used in those provisions to provide aid in computation of cost of new assets.
Conclusion: While computation of capital gain arises from sale of building and/or land appurtenant thereto and a residential house is constructed within three years from the date of such sale, the cost of the new asset, which is eligible for set-off against capital gain, would include the cost of land purchased before the construction. Thus, in computation of cost of new asset contemplated in Section 54(1) of the Income Tax Act, the cost of land cannot be segregated from the cost of the new residential house property. Since the deduction is allowed under Section 54 of the Act, hence cannot be denied under Section 54F of the Act as both the sections are similar in nature.
Ironically, it is too expensive to convince the lower authority for deduction of “Cost of land included in cost of new residential house property” under section 54/ 54F of the Act. However, Appellate authority shall provide some relief to the assessee based on the judgement of Honourable Madras High Court.
Disclaimer: The views expressed herein above are solely the author’s personal views/opinion. This is an informational article and should not be considered as a legal opinion. The possibility of any errors and omissions in the article cannot be ruled out.
1. CA Bhavya Shah is a practicing member of ICAI with L.L.B. qualification and can be reached at firstname.lastname@example.org.
2. CA Ankesh Patni is a practicing member of ICAI and can be reached at email@example.com.