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

Section 54 of the Income Tax Act, allows taxpayers to claim an exemption from Long-term Capital Gains arising from sale of residential house property, when such gains are reinvested in another residential property. The taxpayer must purchase a new residential house within 2 years or construct a new house within 3 years from date of sale. However, the maximum allowed exemption limit is capped at Rs. 10 Crore. 

Overview of Section 54 Exemption

Aspect	Details
Who can claim	Individuals and HUFs only
Capital gains type	Long-term capital gains from sale of residential house property
Exemption limit	Rs. 10 Crore
Tax regime	Available under both old and new tax regimes

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:

1. If the long-term capital gain is Rs. 2 Crore and the cost of acquisition of new residential property is Rs. 3 Crore. Then, the entire capital gain of Rs. 2 Crore is exempt. 
2. If the long-term capital gain is Rs. 2 Crore and the cost of acquisition of new residential property is Rs. 1.5 Crore. Then, the only capital gain up to Rs. 1.5 Crore is exempt, the rest Rs. 50 lakh is taxable. 

The maximum exemption allowed will the capital gain or cost of new residential property whichever is lesser, subject to a ceiling limit of Rs. 10 Crore. 

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 lakh. In June 2015. In October 2015, Mr. Z purchased a new house property of Rs 40 lakh. In January 2017, Mr. Z sold the new property for Rs 55 lakh.

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.
•  As per the latest notification by the department, private sector banks and small finance banks can accept deposits under this scheme. 
• Deposits through UPI, BHIM, NEFT, RTGS, debit cards and credit cards are now accepted under Capital Gains Account Scheme.

Difference Between Section 54 and Section 54F

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.