Overview Of Section 54F Of Income Tax Act
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10 January 2022Depending upon the duration of ownership, capital assets are segregated into two categories- long term capital assets and short term capital assets.
When you sell long-term capital assets, your profit is called a long-term capital gain. Such a profit is taxable as per the Income Tax Act.
However, Section 54F of the Income Tax Act allows tax exemption toward long-term capital gains under specific conditions.
But what are the conditions? Let us find out.
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Table of contents
A Detailed Overview of Section 54F of the Income Tax Act
According to Section 54F of the Income Tax Act, one can avail of tax exemption over long-term capital gains. The condition here is that the capital gain should be earned from selling capital assets other than property.
In simple words, if you make a profit through the sale of bonds, shares or gold, and use the proceeds for the construction or purchase of a property, then that particular amount is eligible for exemption.
Let us understand Section 54F with an example:
Suppose Mr Ravi owns 10,000 shares. He bought these shares at Rs. 50 each. That makes the total cost of buying these shares at Rs. 5,00,000. Now, he decides to sell these shares at a price of Rs. 100 each after a year. Upon selling, Mr Ravi will receive Rs. 10,00,000. In this case, his profit or capital gains would be Rs. 5,00,000 (i.e., Rs. 10,00,000 – Rs. 5,00,000). After receiving this sum, he decides to utilise it for property construction. So, here, he will not have to pay any tax on the capital gain of Rs. 5,00,000.
However, if Mr Ravi wants to utilise the net proceeds for any other purpose, he will have to pay tax on the capital gain.
Conditions to Claim Tax Exemption under Section 54F of Income Tax Act
There are a few basic conditions that individuals need to fulfil to avail of exemption under Section 54F of the Income Tax Act. Find them below:
- Only HUF (Hindu Undivided Family) and individuals are eligible to avail of exemptions under this section.
- Exemption is allowed only on long-term capital gains upon sale of a long-term capital asset, except for a house or property.
- To claim exemption, the sale of the capital asset has to proceed in any of the following ways:
- An individual must have bought a residential property before one year from the sale of assets.
- One must buy a property after two years of selling the assets.
- An individual can utilise the proceeds for property construction within three years from the sale of assets.
- If an individual decides to invest only a part of the proceeds for house construction or property purchase, the capital gain will not be eligible for full exemption. Follow the example below to understand this point in detail:
Suppose Ms Dubey purchases 10,000 shares by paying Rs. 5,00,000. After a while, she sells these shares and earns Rs. 10,00,000. Here, her capital gains would be Rs. 5,00,000 (i.e., Rs. 10,00,000 – Rs. 5,00,000). Now suppose, out of the entire proceeds, she uses only Rs. 6,00,000 for property construction. In that case, the entire amount of capital gain will not be exempted from tax.
In the above example, tax exemption on capital gains will be calculated as follows:
Long Term Capital Gain x Amount Utilised for Property Construction/Net Consideration.
Upon using this formula, the taxable amount will be Rs. 3,00,000 only. The remaining amount, i.e., Rs. 2,00,000 will be taxable as per Ms Dubey’s tax slab rate.
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Obtainable Exemption Amount under Section 54F of Income Tax
The exemption amount under Section 54F of the Income Tax Act depends on the proceeds spent on a property. Here are two different scenarios for tax exemption under this section:
Scenario 1
If a person decides to utilise the entire proceeds towards a house purchase or construction, the whole amount of long-term capital gain is tax-exempted.
Scenario 2
If a person decides to utilise the proceeds partially, then the tax exemption will be applicable partly.
Situations During Which Exemptions Are Not Applicable
There are a few situations in which exemptions under Section 54F are not applicable. Find them below:
- If an individual already has more than one property on the date of asset transfer
- If a taxpayer constructs an additional property in less than three years from the asset transfer date
- In case a taxpayer purchases a new house in less than a year from the transfer date of the asset
Keeping these points in mind will help taxpayers claim tax exemption under Section 54F of the Income Tax Act without any hassle.
Final Word
Section 54F is one of many sections in the IT Act that allows taxpayers to reduce their tax liability. If you are someone who owns long-term capital assets, the above segments might be helpful for you.
Frequently Asked Questions
Ans: Net consideration of a capital asset is the overall value received through the transfer of capital assets minus the expenditures incurred through such a transfer. You can calculate it through this formula: Net Consideration = Invested Amount – Total Consideration.
Ans: There might be certain times when you are unable to utilize the entire proceeds for property construction or purchase. Under this scheme, you can deposit the remaining proceeds in your capital gain deposit account. After this, you can use this amount for property construction or purchase within a span of 2 or 3 years.
Ans: No, as per the Income Tax Act, you cannot transfer or sell your house within three years if you had constructed or bought that house with the net proceeds from capital gains. However, if you still decide to sell your property within three years, the exemption under this section will be withdrawn. As a result, you will have to pay tax on your capital gains for the year of transfer.
Ans: No, exemption under this section is applicable only when you sell any long term capital asset, except for your already existing property. So, if you are selling your current property, you won’t be able to claim an exemption under Section 54F of the Income Tax Act.
Ans: Yes, as an NRI, you are eligible to obtain tax exemption under this section. However, you will have to fulfil certain obligations at first. In addition, you will have to purchase a property and sell the LTCA in India.
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