Taxpayers who earn long-term capital gains from the sale of a residential property can reduce or even eliminate their tax liability by reinvesting the gains in another residential house. The benefit is available under Section 54 of the Income Tax Act, which permits an exemption on long-term when the proceeds are used to purchase or construct a residential property.
Can an Under-Construction Property Qualify?
Yes. A taxpayer can claim exemption under Section 54 by investing in an under-construction residential property. The law allows a period of up to three years from the date of sale of the original asset for completion of construction. Therefore, many taxpayers use under-construction projects as a tax-saving avenue while acquiring a new home.
What is Section 54?
Section 54 provides relief from long-term arising from the sale of a residential house property. To claim the exemption, the taxpayer must reinvest the capital gains in another residential house. The deduction is available only on long-term capital gains and the maximum exemption that can be claimed is capped at Rs. 10 crore.
Who Can Claim Exemption Under Section 54?
The benefit of Section 54 is available only to individuals and Hindu Undivided Families (HUFs). Companies, firms, LLPs, trusts, and other entities are not eligible to claim this exemption.
To qualify, the following conditions must be satisfied:
• The asset being sold must be a long-term capital asset, meaning it has been held for more than 24 months.
• The property sold should be a residential house whose income is taxable under the head “Income from House Property”.
• The exemption available is subject to an overall ceiling of Rs. 10 crore.
• If the capital gains do not exceed Rs. 2 crore, the taxpayer has a one-time option during their lifetime to invest in two residential houses and claim exemption.
• The new residential property must be situated in India. Investment in overseas residential property does not qualify.
• The taxpayer must purchase a residential property within one year before or two years after the sale of the original asset, or construct a new residential house within three years from the date of transfer.
How is the Exemption Calculated?
The amount exempt under Section 54 is restricted to the lower of:
• The long-term capital gain arising from the sale of the residential property, or
• The amount invested in purchasing or constructing the new residential house.
Any balance capital gain that is not covered by the exemption remains taxable.
Section 54 vs Section 54F
While both provisions offer capital gains tax relief, there are important distinctions:
• Under Section 54, exemption is linked to investment of capital gains, whereas Section 54F requires investment of the entire sale consideration for full exemption.
• Under Section 54, any uninvested gains remain taxable, while Section 54F grants proportionate exemption if the full amount is not invested.
• In both sections, the exemption is withdrawn if the new property is sold within three years.
• Section 54 does not restrict ownership of additional houses, whereas Section 54F imposes conditions on acquiring another residential property within specified periods.
• The option to invest in two houses for gains up to Rs. 2 crore is available under Section 54 once in a lifetime but is not available under Section 54F.
Important Points to Remember
• If the cost of the new property is lower than the capital gains, exemption is available only to the extent of investment made.
• The remaining gains may be invested in specified bonds under Section 54EC within six months to claim additional tax relief.
• The new residential property should generally be purchased in the name of the taxpayer claiming the exemption.
• Courts have consistently held that if the taxpayer has invested the required amount within the stipulated period, delays by the builder in handing over possession will not automatically result in denial of the exemption.