Section 54 of the Income Tax Act: Capital Gains Exemption

Investing in real estate remains a preferred option for individuals seeking stable returns with minimal risk. However, profits from property sales attract capital gains tax, which can significantly impact earnings. To provide relief, the Income Tax Act offers various exemptions, including Section 54.

Section 54 enables individuals selling a residential property to reinvest the proceeds in another residential property and claim an exemption on long-term capital gains. This article explores the eligibility criteria, conditions, and process for claiming benefits under Section 54 of the Income Tax Act.

Overview of Section 54 of the Income Tax Act, 1961

Section 54 provides a tax exemption on long-term capital gains from the sale of a residential property, provided the proceeds are reinvested in acquiring or constructing another residential property within the specified timeframe. This exemption applies exclusively to long-term capital gains.

Classification of Capital Assets Under Income Tax

Capital assets are categorized based on their holding period:

• Short-term capital assets: Assets held for 36 months or less are classified as short-term capital assets, and gains from their sale are considered short-term capital gains (STCG).
• Long-term capital assets: Assets held for more than 36 months qualify as long-term capital assets, with gains classified as long-term capital gains (LTCG).
• Special provisions:
• Unlisted shares, land, or immovable property held for over 24 months are deemed long-term capital assets.
• Listed securities, equity-oriented mutual funds, and zero-coupon bonds qualify as long-term capital assets if held for more than 12 months.
• Under Section 54, a residential property must be held for more than 24 months to qualify as a long-term capital asset.

Tax Rates for LTCG and STCG (FY 2023-24 vs. FY 2024-25)

The Budget 2024 introduced changes in capital gains taxation, affecting holding periods and tax rates. The table below presents a comparison:

Product	Previous Holding Period	Previous LTCG Rate	New Holding Period	New LTCG Rate
Equity Mutual Funds	>12 months	10%	>12 months	12.5%
Debt Mutual Funds (>65% in debt)	>36 months	Slab Rate	>24 months	Slab Rate
Overseas Funds	>36 months	Slab Rate	>24 months	12.5%
Gold Mutual Funds	>36 months	Slab Rate	>24 months	12.5%

Eligibility for Section 54 Exemption

To claim benefits under Section 54, the following conditions must be met:

• Only individuals and Hindu Undivided Families (HUFs) are eligible for the exemption.
• The sold property must be a long-term capital asset classified as a residential house.
• The new residential property must be purchased within one year before or two years after the sale of the original property. If constructing a new house, the timeframe extends to three years.
• The new property must be situated in India; properties acquired abroad do not qualify.
• From April 1, 2023, a cap of Rs. 10 crore applies to exemptions under Sections 54 and 54F.

Non-compliance with any of these conditions results in the loss of exemption eligibility.

Calculation of Capital Gain Exemption Under Section 54

The exemption amount under Section 54 is determined as the lower of:

• The capital gains from the sale of the residential property, or
• The investment made in purchasing or constructing a new residential property.

If the reinvestment is lower than the capital gain, the remaining amount becomes taxable.

Example Calculation:

Mr. Rohan sells his house and realizes a capital gain of Rs. 35,00,000. He reinvests Rs. 20,00,000 in a new house. Under Section 54, the exemption available is Rs. 20,00,000, and the remaining Rs. 15,00,000 is subject to taxation.

Provisions for the Transfer of New Property

If the new property acquired under Section 54 is sold within three years, the previously claimed exemption is revoked, and the gains become taxable. The following scenarios illustrate the impact:

Case 1: New Property Purchased at a Lower Value Than Capital Gain

If the cost of the new property is less than the capital gains, the entire gain becomes taxable if the property is sold within three years.

Case 2: New Property Purchased at a Higher Value Than Capital Gain

If the new property cost exceeds the capital gains, the entire gain qualifies for exemption. However, if sold within three years, the exemption is withdrawn, and the gains become taxable.

Capital Gains Account Scheme (CGAS)

If a taxpayer is unable to purchase or construct a property before filing their income tax return, they can deposit the unutilized amount in a Capital Gains Account Scheme (CGAS). This allows tax deferral while fulfilling the investment requirement.

Key conditions:

• Deposits must be made in designated bank branches before the income tax return due date.
• The amount must be utilized within two years (for purchase) or three years (for construction).
• Any unutilized amount after the stipulated period becomes taxable.

Finance Act 2023: Implications for Section 54

The Finance Act 2023 introduced a Rs. 10 crore cap on exemptions under Section 54. Any investment exceeding this limit does not qualify for exemption.

Example:

Mr. Arvind sells a house, earning a capital gain of Rs. 12 crore. He reinvests Rs. 12 crore in a new property. Under the revised rule, only Rs. 10 crore is exempt, and the remaining Rs. 2 crore is taxable.

Distinction Between Section 54 and Section 54F

Conclusion

Section 54 of the Income Tax Act offers a valuable tax-saving opportunity for those reinvesting capital gains from a residential property sale into another residential property. However, taxpayers must adhere to strict timelines and eligibility criteria. With the recent Rs. 10 crore cap, high-value transactions necessitate careful tax planning.

For NRIs and investors managing multiple properties, seeking guidance from tax professionals ensures optimal tax benefits while maintaining compliance with tax laws.

If you have any further questions or need assistance, feel free to reach out to us at admin@ushmaassociates.com or info@nricaservices.com, or contact us via call/WhatsApp at +91 9910075924. 

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Disclaimer: Aim of this article is to give basic knowledge about the topic to people who are not in touch with Indian tax norms. When anybody is dealing with these kinds of cases practically, he shall consider all relevant provisions of all applicable Laws like FEMA/Income Tax/RBI /Companies Act etc.