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1. Introduction

An investment in property involves a lot of thought not only in the financial sense but also in an emotional one. After all, it is one of those decisions that is made after giving considerable time, thought and money. Capital gains on the sale of a property is one of the aspects of Income Tax that always sparks a debate. There has been a difference of opinion most times, leading to different court judgements in different cases. All in all, it is a tricky business.

2. Section 54

This section of the Income Tax Act deals with exemptions availed on the sale of house property. The capital gains obtained from this sale may be re-invested into buying or constructing up to two other house properties. The exemption of two houses was introduced in the Budget 2019, prior to which the exemption was limited to 1 house.

The main purpose of allowing exemptions u/s 54 is to encourage individuals to buy or to construct houses. However, one of the conditions under this section is that if the house is bought through capital gains is to be built or is under construction, the same must be completed within 3 years of the investment being made. This is applicable to both a flat under construction on purchase and a house to be built on a plot purchased.

3. Holding Period for Under-Construction Property

The holding period is an essential component in the calculation of capital gains tax. Since the Income Tax Act has had certain ambiguities with regard to the calculation of holding period for sale of under-construction property, clarity has been provided on the same recently with regard to a decision taken by the Mumbai bench of Income Tax Appellate Tribunal. The case being referred to here is Assistant Commissioner of Income Tax vs Keyur Hemant Shah, April 2nd, 2019.

Facts of the Case

  • The assessee, Keyur Hemant Shah, had sold an apartment on April 4, 2012.
  • After working out the indexed cost of acquisition, LTCG was arrived at.
  • Following this, the deduction u/s 54F of the Income Tax Act was claimed and the LTCG was reduced further.
  • The officer was of the opinion that the flat was purchased by Shah via a Registered Agreement for Sale on March 2010.
  • Therefore, his holding period was less than 36 months.
  • Hence, the gains resulting from it must be treated as Short Term Capital Gains.
  • Shah defended it by submitting that the flat was purchased via an Allotment Letter
    dated February 26, 2008, upon which a substantial payment was made by July 24, 2008.
  • Hence, the resultant holding period would amount to more than 36 months,
    making it a long term capital gain.

Ruling by the Income Tax Appellate Tribunal

The Bombay High Court in the case of PCIT Vs. Vembu Vaidyanathan [ITA No. 1459 of 2016], held in January 2019 that the date of allotment would be treated as the date of acquisition. The ITAT reiterated the same principles.

Example:- Chethan books a flat on 5th June 2016, pays the booking amount on the same date.
An allotment letter is issued by the builder on the same date. An agreement to sell is entered into by Chethan and the builder on 7th July 2016. Chethan sells the under-construction property to  Mr. Darwin on 25th August 2019.

The holding period is calculated based on the date of the letter of allotment, which in this case is the 5th of June, 2016.

4. Case Where Construction Is Not Completed In Three Years

The Income Tax Act, in itself, is not very clear on the stand to be taken in the event where the construction of the house is not completed in three years. Here, “house” refers to the house bought through the proceeds from capital gains. Legal precedent has been set through several court cases on the avail of LTCG exemption under Section 54 and 54F even if the house is not constructed completely within 3 years of purchasing it.

Case Law:- Commissioner of Income Tax vs. Sardarmal and Shanthilal Kothari, 2008

Facts

  • Sardarmal and Shanthilal Kothari had invested their long term capital gains in residential house property and claimed deduction u/s 54F
  • Three years later, the assessing officer visited the property and found it still wasn’t completed upon which the officer denied the 54F benefits
  • The Income Tax Appellate Tribunal in Chennai ruled in favour of the Kothari’s

Judgement passed

“In order to claim benefit under Section 54F, the assessee needn’t complete construction of the house and occupy the same. It is sufficient that the assessee establishes that the entire net consideration is invested within the stipulated period.”

5. Calculation Of Capital Gains On Sale Of  Under-Construction Property

Mr Kiran acquired an under-construction property for Rs. 40 lakhs on the 18th of June, 2016.
He received possession of the property from the builder on 2nd of September, 2017. Mr Kiran then sold it on the 15th of February, 2019 for Rs.80 lakhs. He incurred expenses of Rs. 65,000 on transfer
of property.

Particulars Amount Amount
Sale Consideration 80,00,000
Less:- Selling Expenses 65,000
Net Consideration 79,35,000
Less:- Indexed Cost of Acquisition (40,00,000 x 280/264) 42,42,424
Long Term Capital Gains 36,92,576

 

6. Conclusion

Therefore, the ruling Hemant Shah case provided much clarity as to the taxation of capital gains arising from the sale of an under-construction property. In other words, the basis for deciding whether to treat the above as a short term gain or a long term gain is now established firmly. Also, from FY 2017-18, in the case of immovable property, it is considered long term capital asset when held for a period of more than 2 years. 

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