Section 54 of Income Tax Act - Capital Gains Exemption on Sale of Residential House

Section 54 of the Income Tax Act provides exemptions from long-term capital gains tax, if you reinvest the capital gains in another residential property. You can either purchase another house within 2 years or construct one within 3 years from the date of sale. Exemption can be claimed up to Rs. 10 crore. This helps taxpayers save tax by reinvesting the sale proceeds in a new home, subject to conditions under the Act.

Key Highlights

Important criteria to claim exemption under :

• Section 54 Exemption can be claimed only on long term capital gain on sale of residential house property.
• Up to Rs. 10 crore can be claimed as an exemption
• If the capital gain is within Rs. 2 crore, exemption can be claimed on two residential properties' purchase amount. Otherwise, purchase amount of one property can be claimed.

What is Section 54?

Section 54 provides an exemption from long-term capital gains tax when an individual sells a house and purchases another house using the capital gains. Only long term capital gains on house property sale are exempt under this section. Up to Rs. 10 crore can be claimed as an exemption. 

Conditions for Exemption under Section 54

Under Section 54 of the Income Tax Act, individuals and HUFs can claim exemption on long-term capital gains from selling a residential house if they reinvest in another residential property. Firms, LLPs, companies, or other entities cannot claim this exemption.

Key Conditions:

• The asset sold must be a long-term capital asset (held for more than 24 months).
• The asset should be a residential house property, with income taxable under “Income from House Property”.
• The maximum exemption is capped at Rs. 10 crore.
• However, if the capital gain is within Rs. 2 crore rupees, two houses can be purchased, and exemption can be claimed on both of the purchase amount. (or construction amount). This option is available only once in a life time.
• The new residential property must be located in India. Buying a property abroad does not qualify for exemption.
• The seller must purchase another residential house within 1 year before or 2 years after the sale, or construct a new house within 3 years from the date of sale or from the date of compensation in case of compulsory acquisition.

Failure to meet even one will disqualify the seller from availing the exemption under Section 54.

What is the amount of Exemption available under Section 54 of the Income Tax Act?

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

• Long-Term Capital gains arising on transfer of residential house, Or
• The amount used for purchase or construction of a new residential house property. Hence, the balance capital gains (If any) will be taxable.

To illustrate:

Mr X sells his villa(house property) for Rs 45 lakhs. With the proceeds of the sale, he purchases another villa for Rs 20 lakhs. Capital Gains will be computed as follows

The exemption will be lower of the Capital Gains (Rs 45 lakhs) or investment in new property (Rs 20 lakhs), so the exemption will be Rs 20 lakhs.

Limit for Capital Gains Exemption on Sale of Residential House

Budget 2023: Long-term capital gain exemption will be capped at ₹10 crores on sale of: 

*subject to calculation limits.

New Property Sold Within the Time Limit

If the new house is sold within 3 years from the date of construction or purchase,  then the exemption claimed earlier under section 54 shall be taxable in the year of sale of the new house property.

If the new house is sold within 3 years, then cost of the new house will be computed as follows:  

Example

Mr Z has sold a house property and the capital gains is Rs 25 lakhs/- in June 2015. In October 2015, Mr. Z purchased a new house property of Rs 40 lakhs/- In January 2017, Mr. Z sold the new property for Rs 55 lakhs/- 

Let’s compute the taxable capital gains for Mr. Z FY 15-16 (Property sold in June 2015)

FY 16-17 (Property sold in January 2017)

What is Capital Gains Account scheme?

• The Capital Gains Account Scheme (CGAS) allows taxpayers to claim exemption on capital gains if they have not yet purchased or constructed a new house within the specified time frame. 
• If the new property is yet to be purchased (within 2 years) or constructed (within 3 years), the capital gains must be deposited in a CGAS account before the due date of filing the income tax return.
• Usually, public sector banks offer capital gains account scheme facilities.
• The amount already spent on purchase or construction, plus amount deposited in the CGAS, is eligible for exemption. 
• If the deposited amount is not utilised within the specified time, it will be treated as taxable income in the year when the 3-year period expires from the date of sale of the original asset.

Section 54 v/s Section 54F

Often section 54 and 54F are confused among the taxpayers. Though they both have similar conditions and exemption limits, they allow exemption for entirely different category of capital gains.

Similarities

To claim exemptions under Section 54 or Section 54F, the following common conditions must be met:

• A new residential house property must be purchased or constructed.
• The new property must be purchased within 1 year before or 2 years after the sale of the original asset.
• Alternatively, it must be constructed within 3 years from the date of sale.
• If the capital gains are not reinvested before the tax filing due date or within 1 year from the sale (whichever is earlier), the amount should be deposited in a Capital Gains Account Scheme (CGAS) with a public sector bank.

Differences

Key points to Remember

• Proportionate exemption: If the cost of the new residential property is less than the total capital gains, exemption is allowed only for the invested amount. The remaining gains can be reinvested under Section 54EC within 6 months to claim further exemption.
• The new property must be purchased in the name of the seller to avail the exemption.
• If the builder fails to hand over the property within 3 years, the exemption is still valid, provided the investment was made as per the conditions.