Selling of property at a profit (capital gain) is a normal phenomenon. Soon as the profits are earned, the tax gets attracted. However, Section 54 provides tax exemptions to the seller from capital gains tax arising from the transfer of a house property. Tax exemptions can be claimed irrespective of the fact whether the house property is a self-occupied property or let out. However, there are certain conditions which need to be fulfilled before one can claim this tax exemption.
Who can claim tax exemption of Section 54?
An Individual or a Hindu Undivided Family (HUF) can claim tax exemption under Section 54. This exemption is not allowed to a company or a firm.
When Section 54 tax exemption is allowed?
This tax exemption is allowed when:
- The taxpayer owns a house property.
- Such house property is a capital asset. No exemption is allowed to a broker or a real estate developer if such house property is part of his business stock.
- Taxpayer transfers (sells) such house property.
- Such property is transferred after holding for more than 24 months immediately before the date of transfer (sale). In such a case, long-term capital gains arise from such transfer. The exemption is not available for short-term capital gains.
- Taxpayer buys or constructs a new residential house within the allowed time period.
- The new house should be held for at least 3 years from the date of purchase (or construction).
For instance, Mr A buys two house properties on February 01, 2018– House 1 and House 2. He sells House 1 on December 31, 2019 and House 2 on February 05, 2020. House 1 shall not be eligible for exemption under Section 54 tax exemption as it was held only for 23 months before the date of transfer. Thus, the house is treated as a short-term capital asset. House 2 is a long-term capital asset as it was held for more than 24 months before the date of transfer, thus, eligible for Section 54 exemption.
Where capital gains should be invested?
The tax exemption shall be allowed if an investment is made in one house property situated in India. No exemption shall be allowed for the investment made in overseas or foreign property.
With effect from April 1, 2019, the benefit of exemption under section 54 shall be available in respect of investment made in two residential house properties. The exemption for the investment made, by way of purchase or construction, in two residential house properties shall be available if the amount of long-term capital gains does not exceed Rs. 2 crores. However, if a person exercises this option, he shall not be entitled to exercise this option again for the same or any other year. In other words, a person can exercise this option only once in his lifetime.
When the one-time option of investment in two houses can be availed for Section 54 exemption?
This option can be exercised if you fulfil the following conditions:
- You own one or more residential house properties.
- Such house property is a long-term capital asset.
- Such property is transferred after holding for more than 24 months immediately before the date of transfer.
- You earn long-term capital gains from such transfer.
- The amount of long-term capital gains should be Rs 2 crore or less.
- You buy or construct two new residential houses within the allowed time period.
If you are eligible for this option, you should exercise it immediately in the current year.
When to invest the capital gains?
The taxpayer can invest the capital gains to purchase or to construct a new house. The investment of capital gains per se is sufficient to become eligible for exemption under Section 54. If the taxpayer pays the entire purchase price but does not get the property registered in his name before time-limit, he is still eligible to claim the exemption.
[Purchase of new house] The capital gains should be invested to purchase new house property within 1 year before, or 2 years after, the date of transfer of the original house. Example, if house property is sold on April 15, 2019, the new house should be purchased between April 16, 2018 and April 14, 2021.
[Construction of new house] The capital gains should be invested in the construction of new house property within 3 years after the date of transfer of the original house. Example, if the asset is sold on April 15, 2019, the new house should be constructed between April 15, 2019 and April 14, 2022.
Though a taxpayer has a long window to invest the capital gains, yet if he does not purchase or construct the house property before due date for filing his return of income (for the year in which property was sold), he has to deposit capital gains in a special deposit account opened with a nationalized bank.
Further, the new house so purchased or constructed should be held by the owner for at least 3 years from the date of purchase (date of completion of construction). Otherwise, the tax exemption shall be withdrawn.
What is special deposit account?
It would not be practical for the Income-tax department to wait for 2-3 years (time limit allowed to purchase or construct a house) to tax the capital gains if the taxpayer fails to invest the money in a new house. Therefore, a taxpayer is required to deposit the capital gains in a ‘Capital Gains Deposit Account Scheme’ if he could not invest the money in a new house on or before the due date for filing of return of income (generally July 31 or September 30 after the end of the financial year). The amount invested in such deposit account is also considered for computation of Section 54 exemption.
The taxpayer can withdraw the money from such deposit account for further investment in the new house. If he could not utilize the money for stipulated purposes, the unutilized amount is taxed in the year in which time limit of 3 year expires.
How much exemption is allowed under Section 54?
The amount of exemption to be allowed to a taxpayer under Section 54 shall be lower of the following:
- Actual capital gains from transfer of original house property; or
- Amount invested in purchasing or constructing a new house property (including land) and amount deposited in capital gains deposit account.
Is Section 54 exemption allowed for investment in two houses?
The exemption under Section 54 is allowed only in respect of investment made in one house property. If the capital gain is invested in more than one house, the taxpayer can choose that house which has higher investment for computation of Section 54 exemption.
However, with effect from April 1, 2019, the benefit of exemption under section 54 shall be available in respect of investment made in two residential house properties. This benefit is available only when the capital gains is less than Rs 2 crore. This benefit can be availed only once in a lifetime by the assessee.
What if the new house is transferred against which Section 54 tax exemption was claimed?
The exemption given under Section 54 shall be withdrawn if the taxpayer transfers the new asset within 3 years from the date of acquisition (date of purchase or date of completion of construction). The exemption claimed under Section 54 is withdrawn by way of reduction of an equivalent amount from the actual cost of acquisition of the new asset. When such property is transferred, the capital gain shall be computed in its usual way but the original cost of such asset shall be reduced by the amount of exemption withdrawn.
For instance, if new house property is sold after 2 years but before the end of 3rd year, such house shall be considered as long term capital asset. Thus, the cost of acquisition (as reduced by exemption was withdrawn) shall be adjusted with the inflation using Cost Inflation Index (CII) and the resultant indexed cost of acquisition shall be reduced from sales consideration to compute the capital gains.
Whether Section 54 exemption is available if the plot of land is transferred?
Exemption under Section 54 is allowed if residential house property is transferred. Where a plot of land or any other capital asset (i.e., Jewellery, shares, etc.) is transferred then the exemption should be claimed under another section namely Section 54F.
Whether Section 54 exemption is available if the investment is made in bonds or shares?
Section 54 exemption shall not be available if the capital gain is invested in bonds or shares. However, there are other sections under which exemption can be claimed. The following table enumerates the eligible investments and the relevant sections to claim exemption from tax of capital gain.
|Nature of original asset||Nature of new asset||Exemption available under|
|Residential house property||Residential house property||Section 54|
|Residential house property||Specified Bonds||Section 54EC|
|Residential house property||Specified Shares||Section 54GB|
|Any other capital asset||Residential house property||Section 54F|
|Any other capital asset||Specified Bonds||Section 54EC|
|Any other capital asset||Specified Shares||Section 54GB|