Sec 54 benefit gets forfeited unless taxpayer meets multiple criteria

An ITAT ruling has clarified seller can commit to buy new house much before selling old one

A recent ruling of the Income-Tax Appellate Tribunal (ITAT) has clarified that the seller of a residential property can avail of capital gains tax exemption even if she committed to buy a new house much before selling her old property. The Delhi bench of the ITAT ruled on the applicability of Section 54 of the Income-Tax (I-T) Act in the case of Reema Chawla.

Says Amit Bansal, partner, Direct Tax, Singhania & Co., “Under Section 54, an individual or Hindu Undivided Family (HUF) selling a residential house property can claim the exemption for capital gains if they invest the proceeds in the acquisition, i.e., purchase or construction, of another residential property.”

The case

Chawla sold her old residence in the 2019-2020 financial year and invested the proceeds in constructing a new one. She had entered into an agreement with a builder in 2016 and had also taken a home loan based on it. Says Nikhil Kabra, partner, Ved Jain and Associates, “The assessing officer argued that she wasn’t eligible for a tax exemption under Section 54 because the agreement and loan were from 2016, before the old asset had been sold.”

The ITAT, however, held that Chawla was eligible for the tax exemption. Says Kabra, “The ITAT noted that she had sold her old property in March 2020 and took possession of the new, semi-finished property in March 2021, meeting the three-year criterion of Section 54.”

Mandatory conditions

The taxpayer must adhere to certain conditions to avail of Section 54 benefit. Firstly, the asset being transferred — the residential house—must qualify as a long-term capital asset. After selling the old house, the assessee must purchase or construct a new house. Says Prateek Goyall, partner at law firm MV Kini, “The benefit of Section 54 is applicable exclusively to individuals or HUFs.”

The assessee must adhere to the specified timeframe. Says Bansal, “The new residential property must be purchased either one year before the sale of the old property or two years after the sale of the house property, or constructed within three years of the date of transfer or sale.”

An individual can construct or purchase only one house to claim this benefit.

The Finance Act 2023 restricted the maximum exemption allowed under Section 54. Says Anant Singh Ubeja, senior associate, SKV Law Officer, “If the new property costs more than Rs 10 crore, the excess amount shall not be considered for computing the Section 54 exemption.”

An individual who fails to construct or purchase a new house within the stipulated period can deposit the capital gains in the Capital Gains Account Scheme offered by any public sector bank and avail of this exemption.

Says Pallav Pradyumn Narang, partner, CNK, “In case the capital gain is less than Rs 2 crore, the assessee has the option to buy two properties.”

Beware these pitfalls

All the above-mentioned conditions are cumulative. Says Maneet Pal Singh, partner, I.P. Pasricha & Co., “Even if one condition is not fulfilled, the seller cannot avail of Section 54 exemption.”

The exemption claim under Section 54 must be included in the tax filing for the year when the old property was sold.  

Another common error is claiming exemption under Section 54E instead of 54F, or vice versa, when filing returns.

Another issue that can invite the attention of the tax authorities is not investing the gains before filing an ITR. Says Kabra, “If you are unable to invest your gains before the tax filing deadline, put the uninvested amount in a special capital gains account at a bank. This money must be invested within the set two-to-three-year window.”

If a taxpayer fails to use all the gains within the two-to-three-year period, her leftover amount will become taxable in the third year.

Finally, the new property should be in the taxpayer’s name and not in another person’s name. Says Kabra, “While the courts have sometimes allowed the property to be in a spouse’s name, it’s safer to keep it in your name.”

Capital gains account scheme decoded

- If an assessee is unable to purchase or begin construction of a property before the due date of filing her ITR for the year of transfer, and still wishes to save tax, she can use the Capital Gains Account Scheme

- She can deposit all the unutilised capital gain proceeds from the old house into the account

- This way the new property can be purchased later, and the capital gains from the sale of the old house will not be taxed

- This can be done in authorised/approved bank branches

- The deposit must be made before the due date for filing the return

- The deposited amount must be utilised for purchasing or constructing the house in accordance with the provisions of the law

- The Rs 10 crore exemption limit applies to this scheme also

Source: Singhania & Co.