Section 54 Of The Income Tax Act: Capital Gains Exemption

Income Tax

Mr. Sharma is currently going through a financial crunch and is thinking of selling his residential property. However, he is wondering whether he has to pay taxes for that, and if not, what are the conditions he has to meet. 

The Income Tax Act of India has extended certain exemptions for the citizens, helping them reduce their tax liability. When it comes to selling a residential property, one can avoid paying taxes under Section 54 of the Income Tax Act. That said, in that case, the immovable property has to fall under the long-term asset category. 

Still confused? Let us break it down for you!

Different Categories of Capital Assets Under Section 54

The following can be categorized under ‘capital assets’:

• Land
• House
• Vehicle
• Machinery
• Leasehold rights
• Trademark and patent
• Securities

Capital assets can be categorized as ‘long term capital assets’ and ‘short term capital assets’ based on their holding period. 

What Are Long-term Capital Assets As Per Section 54?

In terms of capital gains, there are two categories these assets are bifurcated in — long-term capital assets and short-term capital assets. The former type belongs to those assets which are held for above 3 years, 2 years, or 1 year by assesses as the case may be. When these types of assets are sold, the profit derived from that can be termed long-term capital gains. 

On the other hand, properties that are held not more than 3 years, 2 years, or 1 year are known as short-term capital assets. As per the norms of Section 54 of ITA, exemptions are only available on long-term capital gains.

To claim benefits of Section 54, a taxpayer has to hold his/her immovable property for a duration of over 24 months. 

Also Read: What Are Capital Assets: Types, Taxation & Exemptions

Exemptions Under Section 54

Section 54 of Income Tax Act provides the guideline for tax exemptions in the following situation: 

Suppose an individual or a Hindu Undivided Family (HUF) sells off their house. If they invest the capital gains to construct or purchase a residential property, they can seek tax exemptions from capital gains.

Partnership Firms, Companies, Limited Liability Partnership firms or other associations or bodies are not eligible to seek tax exemptions under section 54 of ITA.

Moreover, there are a few things that one must remember with respect to seeking exemptions under section 54: 

• The residential property that is sold off has to qualify as a long term capital asset

• The new residential property must be in India

• The seller has to buy a house 1 year before the date of sale/transfer or 2 years after the date of sale/transfer. If he wishes to construct a new house, he has to do so within 3 years of the date of sale/transfer

Please note that these conditions work in sync with one another, i.e, a taxpayer cannot avail of exemptions if any one condition remains unfulfilled.

Also Read: Differences Between Taxes On Long-Term and Short-Term Capital Gains

Amount of Exemption Applicable Under Section 54 of The Income Tax Act

The tax exemption available for long-term capital gains under Section 54 of Income Tax Act will be the lower of these two:

• Amount of long-term capital gains that arise with the transfer of residential property.
• The amount being invested for the purchase or construction of a new residential house. In this case, if there is any balance amount or remaining capital gains, it will be taxable according to the Income Tax Act, 1961. 

That said, to receive such benefits, individuals must know all mandatory conditions and eligibility requirements under this section. 

Section 54 Provisions Related to Transfer of Property

Given below is the provision related to the transfer of a property after claiming benefit under section Section 54:

If someone sells their house within 3 years from the date of purchase/construction, the exemption that he had claimed earlier under section 54 will be taxable in the year he sells the new house. 

The following case study will illustrate this further:

Arun Lal sold off his residential property (long term capital asset) in June 2019. The capital gain was Rs. 30,00,000. In the following month, i.e., July 2019, Arun Lal bought a new house worth Rs. 15,00,000. 

He sold off this new house (bought in July 2019) in October 2020 for Rs. 35,00,000. 

Based on the above facts, the taxable gains are calculated below:

FY (2019 -2020)

FY (2020-2021)

Arun Lal sold off his new house within less than 3 years from the date of acquisition. Therefore the Cost of Acquisition is nil. Moreover, the entire amount is considered capital gains. 

If Mr. Lal had sold off his house (bought in July 2019) after 3 years, he could have claimed the acquisition cost as a deduction, and the taxable capital gains would have been reduced. 

Eligibility Requirements for Claiming Exemptions Under Section 54 of The Income Tax Act?

Here are some parameters you must meet to avail tax benefits under Section 54:

• The immovable asset has to be a residential property and should be held for more than 24 months. 
• You must be an individual or a member of a Hindu Undivided Family (HUF).
• The residential property should be within India. The exemptions are not available on properties outside of this country.
• The purchase of the residential house should be either 2 years after the sale or transfer or one year prior to the sale or transfer. 

Apart from these, also remember that you can avail of these tax benefits only once for this kind of transaction. In case you fail to meet any of the above-mentioned criteria, tax exemption under Section 54 will be unavailable. 

Also Read: Section 10 Of Income Tax Act

What is the Significance of Capital Gains Account Scheme?

Taxpayers can deposit their capital gains in capital gains account schemes in the following situation:

Suppose a taxpayer sells a capital asset in a particular year and wishes to buy a residential property with the capital gains. However, he has to wait for some time as the time limit for 3 years has not yet expired. 

Then, he can deposit the amount in a capital gains account scheme before the date of filing ITR. One can deposit the requisite amount at any capital gains account scheme in any branch of any public sector bank. 

However, one should note that if he/she does not use the amount deposited in a capital gains account scheme within the stipulated time, Income Tax officials will deem it as the income of the previous years. 

Also Read: Section 112A Of Income Tax Act: Tax On Long-Term Capital Gains, Calculation And How To File ITR

Difference Between Section 54 and Section 54F

Given below are the differences between Section 54 and Section 54F

Additional Pointers to Remember Regarding Section 54 of The Income Tax Act

Although you are aware of most of the conditions of Section 54 of Income Tax Act, here are some additional points you must keep in mind:

• In case the total sale amount is higher than the total cost of the new house, tax exemption is available proportionately. Moreover, the remaining amount will be applicable for reinvestment and can be done within 6 months under section 54EC.
• The seller must ensure to buy the property under his/her name. 
• The exemption will be available even if the builder delays in handing over the new residential property to the assessee within 3 years of its purchase. 

Final Word

Now, it is pretty clear that you can save taxes while selling your residential property under Section 54 of Income Tax Act. Note that from AY 2020-21, a capital gain exemption will be applicable in the case of two residential house purchases within the country. However, the capital gain must not exceed Rs. 2 crores.

FAQs on Section 54 of The The Income Tax Act

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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.