The author has explained the intricacies and meaning of Section 54 of the Income Tax Act, 1961 in the present Article. [Exemptions from Capital Gains]
Section 54 of Income Tax Act: Exemption for Capital Gains
Many homeowners must sell their homes for a variety of reasons, including relocating to a new area, changing jobs, retiring, and so on. According to section 54 of the Income Tax Act, if a seller of a residential property purchase or constructs another residential property with that money, he or she is entitled to capital gains tax benefits.
Thus, under Section 54 of the Income Tax Act, an assessee is excluded from capital gains when he or she sells a residential property and buys or builds another residential property.[i] Since an individual needed to relocate for a variety of reasons, he sold his old home and used the money to buy a new one.
The seller’s goal, in this case, was not to make money by selling the old house but to find some other suitable home. It would be a disadvantage for the seller if he were to pay income tax on capital gains resulting from the selling of the old building. Section 54 provides relief from such a hardship. It provides tax exemption to a taxpayer who sells his primary residence and buys another primary residence with the proceeds of the sale.[ii]
Moreover exempts persons and Hindu Undivided Families (HUF) from paying tax on long-term capital gains resulting from the sale of a residential property if certain conditions are met. The section was created to alleviate the rigours of tax liability under Section 45 and to promote residential property investment.[iii]
A residential house selling is a capital asset sale, and the benefit is taxed as a capital gain. Property of any kind, movable or immovable, tangible or intangible, owned by the assessee for any reason is included in the scope of a capital asset under section 2(14) of the Income Tax Act. Assets are divided into two categories for capital gains purposes under the income tax act, based on how long they have been held:[iv]
- Short Term Capital Asset: A short-term capital asset is owned by a person for less than 36 months. From FY 2017-18 onwards, the 36-month criteria for immovable assets such as land, buildings, and houses have been reduced to 24 months.
- Long Term Capital Asset: Long-term capital assets are those that have been retained for more than 36 months. Movable property, such as jewellery and mutual funds, is not eligible for the limited duration of 24 months. These movable properties would be listed as a long-term capital asset if kept for more than 36 months, as previously stated.[v]
In the case of CIT v. Ananda Basappa,[vi] it was decided that the phrase “a residential house” should not be interpreted as referring to a single number. The assessee is entitled to a deduction under section 54 because he bought two residential flats that are next to each other and the contractor combined them into one unit.
The conditions under section 54 are:
- Asset should be a long term capital asset.
- A Residential House is a commodity that was sold. The income from such a house must be taxed as House Property Income.
- A residential house should be purchased by the purchaser either one year before or two years after the date of sale or move. If the seller is building a home, he or she has an extra three years from the date of sale/transfer to complete the project. If the compulsory acquisition is required, the acquisition or construction period will be determined by the court.
- India should be the location of the new residential building. The seller cannot seek the exemption if he or she buys or sells a home in another country.
The conditions mentioned above are cumulative. As a result, even though one of the conditions is not met, the seller is not eligible for the Section 54 exemption.
The Finance Act of 2019 amended Section 54 with effect from Assessment Year 2020-21 to expand the value of exemption in respect of investments made in two residential house properties. If the amount of long-term capital gains does not exceed Rs.2 crores, an exemption would be applicable for investments made by way of acquisition or development in two residential house properties.
Amount of Capital Gain Exempted under Section 54
The lower of the two is allowed as an exemption sum for a taxpayer under Section 54 of the Income Tax Act:
- Amount of capital gains on transfer of residential property or
- An investment made for building or buying a new residential property.
The remaining sum (if any) would be taxed in accordance with the income tax act.[vii]
In the case of I.T.O. v P.C.Rama Krishna,[viii] the assessee purchased two flats in the same house, one on the ground floor and the other on the third floor. Since the two flats were in the same house, it was agreed that the assessee could seek benefits under section 54.
In the case of Prem Prakash Bhutani v. ACIT,[ix] a capital gains deduction was permitted where the assessee purchased three flats in the same house. It was decided that the residential house must be a structure, and that section 54 does not require the structure to be built in a particular way.
In the case of Jt. CIT v. S.K.Jasani,[x] by installing an internal staircase, the assessee was able to turn two flats on separate floors into a residential unit. The exception under section 54 was allowed because the proceeds of the transfer were invested in the purchase of two flats within a short period of time. As a result, two flats were deemed to fall under the definition of “a residential building.”
Deductions under section 54 were permitted in Vyas (K.G.) v ITO[xi] when the assessee bought four flats on separate floors in the same house.
The exception under section 54 cannot be asserted if the assessee purchased seven houses in a row by seven different purchasing agreements. In the case of Krishnagopal Nagpal v. DCIT,[xii] the court reached this conclusion. The logic was that each row house could be used as a single unit independent of the others. As a result, a deduction can be provided for the purchase of one residential home.
Several self-occupied dwelling units that were contiguous and located in the same compound and within the common boundary and had unity of structure should be considered as one residential home, according to the decision in Shiv Narain Chaudhari v. CWT.[xiii]
In Shri Humayun S. Rangila v. ITO,[xiv] the assessee sold two flats and bought two new flats with the proceeds. The exemptions would apply to any number of residential houses as long as other section 54 requirements are met, it was decided. The selling of any number of residential properties will be exempted as long as there are corresponding investments. The total capital gain is impossible to quantify. The deduction must be determined for each combination of sale and expenditure that benefits the assessee the most. In Rajesh Keshav Pillai v. ITO,[xv] the assessee sold two flats and used the capital gain from the sale to buy two more flats. The exception can only be sought on a one-to-one basis when more than one house is sold and purchased, and each package of
[i] Section 54 of the Income Tax Act: Capital Gains Exemption, https://tax2win.in/guide/section-54-of-income-tax-act
[ii] Section 54 Exemption for Capital Gains Arising on Transfer of Residential House Property, Income Tax Department, https://incometaxindia.gov.in/tutorials/16.%20exemption%20under%2054.pdf
[iii] Transfer of Residential Property: Capital Gains and Exemptions under Ss. 54 & 54F, http://saprlaw.com/taxblog/s54.pdf
[iv] Section 54 of Income Tax Act – Capital Gains Exemption, https://cleartax.in/s/section-54-capital-gains-exemption#:~:text=Under%20Section%2054%20the%20IncomeTax,or%20construction%20of%20residential%20property.&text=The%20seller%20cannot%20buy%20or,abroad%20and%20claim%20the%20exemption.
[v] Ritesh Sonavane, What is a Capital Asset? And What are Long Term and Short Term Capital Assets, https://blog.kohinoorpune.com/what-is-a-capital-asset-and-what-are-long-term-and-short-term-capital-assets
[vi] (2009) 223 CTR (Kar) 186.
[vii] Supra Note 1.
[viii] (2007)107 TTJ (Chennai) 351.
[ix] 110 TTJ (Del) 440 ( 2007).
[x] Reported in BCAJ, August, 2005
[xi] 16 ITD 195 (Bom.)(1986).
[xii] (2004) 82 TTJ (Pune) 481.
[xiii] (1977) 108 ITR 104.
[xiv] ITA No.1239/M/2010 Mumbai.
[xv] 7Taxmann 11 (Mum) (2010)
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