Section 54: Exemptions on Capital Gain on Transfer of Property

Section 54 of Income Tax Act for Exemption on Capital gain arises on transfer of a capital asset. Capital Asset includes land, building, plant and machinery, share and debenture etc.

When capital gain arises then it is chargeable to tax and you have to pay tax on gain on transfer of capital asset.

But Income Tax Act 1961 has given some relief in the form of exemptions. You can avail exemption and can avoid payment of tax on capital gain.

The exemption will be given on fulfilling certain conditions.

One of such exemptions is exemption of capital gain on transfer of residential property.

Who is eligible for availing exemption under section 54?

This exemption is allowed to individuals or HUF only. Companies, LLP and firms are not eligible for availing exemption.

What are the conditions for availing exemption under section 54 on capital gain on Transfer of residential property?

Suppose you sell the residential property and gain arises. On this gain, you have to pay taxes in the form of capital gain.

But if you fulfill certain conditions then you can avail exemptions from paying tax.

Following are the two conditions to avail exemption:

Asset transferred

For this section 54, exemption is available only for the gain arising on transfer of residential property means if you transfer commercial property then no exemption is available, so for availing exemption residential house property must be transferred.

Long term capital gain

Exemption is available only if the gain is Long term capital gain and not short term capital gain. Long term capital gain arises if the property transfers after 24 months from the date of purchase.

Investment conditions

Exemption is available if the assesse purchases one residential house in India and that house must be purchased within one year before or two year after the date of which transfer took place.

For example: Suppose if Mr A sells its residential house on 01/11/2018, then he has to purchase one house within one year before i.e. between 01/11/ 42017 to 31/10/2018 or 2 years after i.e. between 01/11/2018 to 31/10/2020 the date on which transfer took place.

or assessee can construct one residential house in India and that construction must be within 3 year after the date of transfer.

For example: if transfer took place on 01/11/2018 then construction must be within 01/11/2018 to 31/10/2021.

However an option is given to assessee that if amount of capital gain doesn't exceed Rs. 2 Crore then may at his option:

Purchase two residential house in India and that house must be purchased within one year before or two year after the date of transfer took place. OR
Assessee can construct two residential house in India and that construction must be within 3 years after the date of transfer.

The point to be noted is that the property you purchase or construct must be in India. The exemption will not be available if you purchase for construction residential property outside India.

Also Read: Capital Gain Tax on Sale of Property (Long Term / Short Term)

What is the amount of exemption available under section 54 of capital gain on transfer of residential property?

The exemption is available upto the amount you invest in purchasing or construction residential property but maximum exemption is available only up to the long term capital gain arising on transfer of your earlier property.

For example: Mr A sells its residential property for rupees 50 lacs and long term capital gain arise rupees 20 lacs and if Mr A invest all its gain of rupees 20 lacs in purchase of or construct of residential house then he can claim full rupees 20 lacs as exemption but if he invest only a part of it say rupees 10 lacs then only rupees 10 lacs exemption is available.

But if he invests rupees 25 lakh then only 20 lakh exemptions is available that is upto the maximum of long term capital gain.

What happens in case of withdrawal of exemptions under section 54?

The new house you purchased or constructed for the purpose of availing exemption must be held for a minimum 3 years period. If you transfer the new house within three years then the exemption allowed will be withdrawn.

The withdrawal is done in such a way that it reduces your cost of acquisitions.

For example: Mr A avail earlier examinations of rupees 20 lacs on transfer of residential property and he purchase a new residential house for rupees 30 lacs, now if Mr A sells this new house within 3 years for rupees 50 lakh then exemption of capital gain is as follow:

Particulars

Amount (Rupees)

Full value of consideration

(-) cost of acquisition 30,00,000

Less: Exemption earlier availed (20,00,000)

50,00,000

-10,00,000

40,00,000

Now you gain will be rupees 40 lakh and you have to pay tax on it.

But if you sell after completion of three years then your cost of acquisition is rupees 30 lakh in full and then you have to pay tax on rupees 20 lakh only.

Provision of capital gains account

The problem in this section is that you purchase or construct residential house within a time period of two or three years but the gain is taxable in the year in which transfer took place.

So for this, there is a provision for capital gain account scheme. In which, the amount of gain has to be utilised for purchase or construct till the last date of filing of income tax return.

And if it is not possible then you have to deposit the amount in capital gains account scheme, 1988 then only exemption is available in the year in which transfer took place.

After that, the amount should be utilised for purchase or construction of residential property. If mis-utilisation then the exemption availed become long term capital gain of the year in which amount is misutilised.

Also Read: Capital Gain Tax - Long Term & Short Term in India

Conclusions

Section 54 of Income Tax Act says about exemption on capital gain on transfer of residential property, which provides a tax saving exemption only if you fulfill certain conditions.

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