Exemption on purchase of residential house property- Section 54 of the Income Tax Act

Shifting from one city to another has become a quite frequent phenomenon nowadays majorly due to job transfers & job switching. As a result, many people are compelled to sell their residential property in one city and purchase another one in another city. Those people would be interested in knowing how could they save income tax on the sale of residential house property while filing income tax return by means of acquiring new residential house property under section 54 of the Income Tax Act. In this article, we will discuss the exemption under section 54 of the Income Tax Act, 1961.

What is section 54 of the Income Tax Act?

Selling a capital asset in India attracts capital gain tax under the Income Tax Act. Such capital gain is taxable either as a long-term capital gain or as a short-term capital gain. Section 54 of the Income Tax Act provides relief in the form of exemption from long-term capital gain tax on the sale of residential house property. Such exemption could be claimed by an individual or HUF. The exemption under section 54 is available where any individual or HUF sells any residential house property and re-invests the proceeds in the purchase of another residential house property.

What is a Capital Asset?

Any kind of property which is owned by any person is known as a ‘Capital Asset’. Such property may be related to the business of the person or not. However, there are certain exceptions such as inventory, movable items of personal use (other than ornaments), and rural agricultural land which are not treated as ‘Capital Asset’. Capital assets can be broadly categorized as follows:

• Immovable Property: Land & Building, Flats, Urban Agricultural land
• Movable Property: Bullion, Jewellery, Artifacts, Paintings, sculptures, drawings, etc.
• Investments: Shares, Debentures, Bonds, Mutual Funds, ETFs
• Tangible Assets held in business: Land, Shop, Factory Building, Machinery & equipment
• Intangible Assets held in business: Patents, Trademarks, Copyrights, etc.

Read More about Capital Assets

For the purpose of income tax, capital assets are classified into two parts:

• Long-Term Capital Assets
• Short-Term Capital Assets

Long Term Capital Assets

Any capital asset held for more than 36 months (3 years) is treated as a ‘Long-Term Capital Asset’. Gains on the sale of such asset is regarded as ‘Long-Term Capital Gain’ and is taxable at a special flat rate.

There are a few exceptions to 36 months rule as below:

• In the case of unlisted shares & land or other immovable property, the period of 24 months (2 years) is considered instead of 36 months for treating them as ‘Long-Term Capital Asset’.
• In the case of listed securities including units of equity-oriented mutual funds, the period of 12 months is taken instead of 36 months for treating them as ‘Long-Term Capital Asset’.

Short Term Capital Assets

Any capital asset other than the long-term capital asset is termed a ‘Short-Term Capital Asset’. Gains on the sale of the short-term capital asset is known as ‘Short-Term Capital Gains’.

Note: Thus, it is clear from the above discussion that in the case of a residential house property, the minimum holding period of 24 months is necessary to be considered as a ‘Long-Term Capital Asset’.

Who is eligible to avail of the benefits of section 54 of the Income Tax Act?

Exemption under section 54 of the Income Tax Act is available where an assessee sells a residential house property (long-term capital asset) and buys another residential house property. The following conditions are to be satisfied for availing of Section 54 exemption:

• Only Individual or HUF assessees are eligible to claim an exemption under section 54. Thus, Partnership Firms/ LLPs/ Companies are not entitled to claim an exemption under this section.
• Individual or HUF must have sold a residential house property which is a long-term capital asset i.e. it was held for more than 24 months.
• The house property sold should be ‘residential’ in nature i.e. Income from such property is chargeable under the head ‘Income from House Property'.
• Exemption under section 54 will be available if you purchase a new residential house property either one year before the date of transfer or within two years from the date of sale or transfer. Otherwise, you can also construct a new residential house property within 3 years from the date of sale or transfer.
• Most importantly, the new house property bought or constructed should be located in India to avail of section 54 exemption.

In case any of the above conditions are not satisfied by the person, he shall not be eligible to claim an exemption under section 54 of the Act.

What is the amount of exemption available under section 54?

According to section 54 of the Income Tax Act, the entire amount of long-term capital gains shall be exempt from tax if the investment in the residential house property is equal to or more than the amount of capital gains. If the investment is less than the capital gains amount, the exemption will be available to the extent of the amount of investment made.

For example: Ramesh sells his residential flat for Rs. 65 Lakhs and earns a long-term capital gain of Rs. 32 Lakhs. He purchases a new residential flat for Rs. 37 Lakhs. In this case, the entire amount of capital gain will be exempt as the amount of new investment is more than the capital gain amount.

Suppose, he purchases a new flat for Rs. 28 Lakhs. In this case, long-term capital gain shall be exempt up to Rs. 28 Lakhs, and the balance of Rs. 4 Lakhs of gain shall be liable to tax @ 20% at the time of ITR filing online.

What are the conditions to avail exemption under section 54?

The taxpayer needs to fulfill the following conditions to avail of the exemptions under section 54 as below:

• After the sale of residential house property, you are required to purchase new residential house property either one year before the sale of the old property or two years after the sale of such property or construct a new residential house property within 3 years of the date of transfer or sale.
• Exemption under section 54 of the Act can be claimed only in respect of the purchase or construction of one residential house property. However, Finance Act, 2019 gave a lifetime option which can be taken only once in a lifetime of the assessee where the assessee can purchase or construct two residential houses in India in case the amount of capital gain does not exceed Rs. 2 crores.
• Therefore, if your capital gain exceeds Rs. 2 crores then you will have to purchase or construct only one residential house in India and if your capital gain is up to Rs. 2 crores then you can avail one life time option of purchasing or constructing 2 residential house properties. The option is to be exercised while doing ITR filing.
• But if the option is once exercised, you will not be able to claim exemption u/s 54 by way of purchase or construction of 2 house properties in the future.

• If you are not able to buy/ construct a new house within the stipulated time, then you can deposit the capital gain amount under Capital Gains Account Scheme.

What is Capital Gains Account Scheme?

If you are unable to purchase or construct a new residential house property up to the date of filing income tax return after selling the property, you need to deposit the capital gain amount to a separate Capital Gain Account. Later, the amount deposited in this account is to be utilized within the stipulated time period of 2/3 years as prescribed under section 54 of the Act.

If the unutilized capital gain amount is not deposited by the assessee in the capital gain scheme before the due date of filing ITR, he/she will be liable to pay income tax on capital gains even though he/she intends to buy or construct the new house within the time limit of 2/3 years.

Conditions attached to Capital Gains Account Scheme

• Deposit in Capital Gains Account is to be made in an authorised/ approved bank branch (Rural branches are not included)
• Deposit is required to be made before the due date of filing income tax returns.
• The amount deposited in the capital gain account has to be utilised to buy or construct a new house as per the time limit prescribed under section 54 of the Act.
• If you fail to utilise the entire amount deposited in the capital gain account within the stipulated time of 2 or 3 years, the remaining unutilized amount shall become taxable and you will have to pay tax on that amount.

Consequences of transferring new house property within 3 years

Section 54 restricts the sale or transfer of the new residential property for which the assessee has claimed an exemption u/s 54. According to this, the assessee is mandated to hold the newly bought/ constructed house property for at least 3 years.

If the assessee sells the new residential house property within 3 years from its purchase or construction, the entire capital gain exempted earlier will now become taxable and he/she will have to pay capital gain tax on such amount.

Conclusion

Section 54 of the Income Tax Act has been inserted in the Income Tax Act with a view to promote investment in residential housing. You can take maximum benefit of this section and save tax @ 20% on long-term capital gain on sale of the residential house. While taking benefit under section 54, don’t forget to open a capital gain account if the capital gain amount couldn’t be utilised before the due date of filing income tax return.