Understanding Capital Gains Exemption on the Sale of Residential House Property
Ready to sell your house? Learn all the ins and outs of capital gains exemption in this guide.
Understanding Section 54 of the Income Tax Act – Capital Gains Exemption
Are you interested in investing in a property?
Why? Let us guess the reasons.
You want to keep it for several years and sell it for a higher price? Right? Although selling is totally optional here but, many individuals do it for various reasons, like due to a new job, moving to a different city, or retiring. This is where Section 54 of the Income Tax Act plays a major role. It provides significant benefits in terms of capital gains tax exemption.
Do you also want to avail these benefits? But wait! There are several things that you need to understand, which Karr Tax experts will discuss here in this guide.
What Is Section 54 of The Income Tax Act, 1961?
Section 54 of the Income Tax Act is a provision that provides relief to individuals from paying tax on capital gains when they sell a residential property and use the sale proceeds to acquire or construct another residential property.
It's like a tax break for people who are more interested in finding a new place to live than in making a significant profit from the sale of their house.
What are the types of capital assets under the Income Tax Act?
Capital assets are of two types.
● Short-term capital asset
➔ This category includes assets that are held for up to 36 months.
● Long-term capital asset
➔ Assets held for more than 36 months from the transfer date.
➔ If the holding period of all the unlisted shares and other immovable properties, including land, buildings and machinery, is more than 24 months.
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Who Is Eligible to Claim Capital Gain Exemption?
Tax-saving benefits of section 54 are extended to individuals and Hindu Undivided Families (HUF) who sell a residential property that is classified as a long-term capital asset and subsequently invest in the purchase or construction of another residential property.
One must meet the following eligibility criteria to make the most of this exemption.
● The benefit is exclusively available to individuals and Hindu Undivided Families. This means this capital gain exemption is unavailable for the company, LLP, or firm.
● The property being sold must qualify as a long-term capital asset.
● The property being sold must be a residential house, and any income generated from it should be categorized under the head "income from house property."
● The new residential property being purchased or constructed must be situated in India. Only transactions related to properties within the country are eligible for the benefits under Section 54.
● In instances where the capital gains surpass the ₹2 crore mark, the taxpayer is presented with two options.
➔ They can either opt to purchase a new property within one year before or two years after the transfer.
OR
➔ They can undertake the construction of a residential house within a period of three years after the transfer date.
● When the capital gains amount falls below ₹2 crore, have the flexibility to exercise one of the following choices.
➔ Procure two residential houses within one year before or two years after the transfer.
OR
➔ Initiate the construction of two residential houses within a span of three years following the date of the transfer.
● Starting from April 1, 2023, a noteworthy change has been introduced in capital gains tax exemptions. Finance Minister Nirmala Sitharaman has restricted the capital gains tax exemption at ₹10 crores for selling the first residential property. Previously, there were no restrictions.
What is the total Capital Gain Exemption available u/s Section 54?
The determination of the capital gain exemption amount under Section 54 involves evaluating the lower of two factors.
● Long-Term Capital Gains
The capital gains arising from residential property transfer.
● Investment in New Residential Property
The amount invested in the purchase or construction of a new residential house property.
The exemption granted will be the lesser of these two values, meaning that any remaining capital gains, if applicable, will be subject to taxation. To illustrate this concept, let’s take an example.
Mr. Rahul sells his apartment and earns a capital gain of ₹ 60,00,000/-. Then, he utilizes the sale amount to acquire a new apartment for ₹ 30,00,000/-
The Capital Gains exemption under section 54 will be the lower amount, i.e., ₹ 30,00,000/-
The taxation on capital gains will be the balance of both, as defined below.
₹60,00,000-₹30,00,000 = ₹30,00,000 |
Is Section 54 and Section 54F the same?
No, Section 54 and Section 54F are not the same. These both are related to exemptions on capital gains but apply to different scenarios.
Particulars | Section 54 | Section 54F |
Applicability | If you sell a residential property and make a profit from holding it long-term. | It applies to every asset sale other than residential property. |
Additional Requirements | No other specific conditions | The individual should not own more than one house already. |
CGAS Scheme for claiming Capital Gain Exemption
If taxpayers will not be able to use the full sale proceeds for a new property by the ITR submission due date, they can deposit the unutilized funds in the Capital Gains Deposit Account Scheme (CGAS).
This allows them to claim an exemption for both the amount spent on property and the funds in CGAS. However, if the deposited amount isn't used within 3 years, it becomes taxable income in the last year.
Consequences For Transfering New House Property
When you claim a capital gain exemption under Section 54 of the Income Tax Act and decide to sell your recently acquired home, there's a 3-year waiting period you should know about. Here's what could unfold in different scenarios:
Scenario 1: Selling the New Home Too Early (before 3 years) and it Costs Less than What You Made
What Happens: If the individual sells the new property before holding it for at least three years, the exemption initially granted under Section 54 will be withdrawn. The individual becomes liable to pay taxes on the capital gains that were previously exempted.
Scenario 2: Selling the New Home Too Early, but it Costs More than What You Made
What Happens: The capital gain exemption will still be withdrawn. However, the individual can claim the acquisition cost (Total Purchase Price – Exemption u/s 54).
Scenario 3: Waiting Over 3 Years Before Selling the New Home
What Happens: In this situation, the taxpayer can claim the exemption under section 54.
Scenario 4: Builder Delay in Handing Over the Property
What Happens: The exemption is still allowed if the builder fails to deliver the new residential property to the taxpayer within three years of purchase. This recognizes situations where factors beyond the individual's control, such as construction delays, impact the timeline.
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