Section 54 of Income Tax Act 1961 provides tax exemption on capital gains that result from sale of residential house property. In this article we will discuss about tax exemptions available under section 54 in detail.
Conditions to be satisfied under section 54
Who can claim exemption under section 54 of Income Tax Act?
Any individual or Hindu Undivided Family (HUF) owning a residential house property can claim tax exemption under section 54 of Income Tax Act 1961.
Eligibility of Assets Sold
A Residential House Property that is sold after a period of minimum 3 years from the date of its acquisition is treated as a long term capital asset and is covered under section 54 for tax exemption.
Assets to be acquired
You need to acquire a Residential House Property to claim tax benefits under section 54 of Income Tax Act 1961. A plot is not covered under the definition of residential house property. Hence, tax exemption will not be available on the purchase of plot alone.
Clauses of Section 54 to be satisfied to claim Exemption
Under section 54 of IT Act, you can claim tax exemption on long term capital gains from sale of residential house property by investing such gains in either
- Purchase of one residential house property within 1 year before or 2 years after the date on which the property sold is transferred to the new buyer or
- Construction of one residential house property within 3 years from the transfer date of the property sold.
How to Calculate Capital Gain?
You can calculate your Capital Gain by the formula,
Long Term Capital Gain = Sale Consideration – (Indexed Cost of Acquisition + Indexed Cost of Improvement + Cost of Transfer)
Sale Consideration is the total amount received by you in consideration for sale of your house property.
Indexed Cost of Acquisition is the original cost of acquisition of property adjusted for inflation, as calculated by the formula
Indexed Cost of Acquisition = Actual Purchase Price * (CII of Year of Sale/ CII of Year of Purchase)
Indexed Cost of Improvement is the inflation adjusted cost incurred in making any improvements, additions or modifications to the property, as calculated by the formula
Indexed Cost of Improvement = Actual Cost of Improvement * (CII of Year of Sale/ CII of Year of Improvement)
Check out our detailed article on Cost Inflation Index (CII) to know how to calculate indexed cost of acquisition and improvement for various situations.
Cost of transfer includes expenses incurred in sale transaction such as brokerage, advertisement costs, registration & stamp duty charges etc.
Also Read – Capital Gain on Sale of Property. This article gives an overview of tax exemption rules for all types of properties.
You can claim tax exemption on capital gain upto the extent it is invested in the purchase and/ or construction of another house property. This can be elaborated further as follows:
- If Capital Gain < Cost of New House, then entire Capital Gain Amount is exempted, and
- If Capital Gain > Cost of New House, then you can claim exemption upto the cost of new house.
Important Points regarding Section 54
An amendment to section 54 of Income Tax Act was introduced in Budget 2014 according to which starting Financial Year 2014-15, exemption under section 54 will be available only if the capital gains amount will be re-invested in 1 residential house only.
Capital Gains Account Scheme
In order to avail tax exemption under section 54 you must do either of the following before filing income tax returns for the year in which you sold the property.
- Invest capital gains amount in a residential house property, or
- Deposit your entire capital gain amount in a Capital Gain Account Scheme (CGAS) until you purchase or construct your house property.
Otherwise, your entire long term capital gain will be treated as taxable.
In other words, under section 54 you need to purchase another house property within 2 years or construct a house within 3 years from the date of sale of first property. Until you purchase your second house property, you can deposit your capital gain amount in a CGAS account and avoid capital gain tax.
Check out this detailed guide on Capital Gain Account Scheme 1988 to learn about types of CGAS accounts, the process of opening an account and other details about CGAS account.
Frequently Asked Questions
1. Can I claim tax exemption under section 54 on sale & purchase of multiple residential houses?
Let us explain this with an example. Say, you sold 3 residential houses and bought 3 residential houses. Under section 54, you can claim tax exemptions for each set of sale and corresponding purchase of another house property. This means you will have to calculate your capital gains and claim exemption for 3 sets of sale & purchase of properties. You cannot calculate capital gain on aggregate sale & purchase amounts.
2. I sold two houses and invested the proceeds in one residential house. Can I claim exemption under section 54?
Yes. If you sold two houses in one financial year and invested capital gains in one house in the same year, you can claim tax exemption under section 54. The date of transfer in this case will be taken as the transfer date of first house sold.
3. Is the relief under section 54 available if the capital gains are invested to purchase more than two houses?
As per latest amendment introduced in Finance Bill 2014, exemption under section 54 is available only if the capital gains amount is re-invested in 1 residential house. So, you can claim deductions on one of the two houses purchased.
4. I have purchased a property in joint name with wife. Can I claim tax benefit on long term capital gains under section 54?
Yes. Section 54 stipulates that the house should be purchased by assessee and not necessarily in the name of the assessee.
5. Whether allotment of a flat under a group housing scheme is treated as purchase or construction of a house?
Allotment of flat under a group housing scheme shall be treated as construction of the house.
6. In an under construction property, whether date of allotment or delivery of possession of flat should be considered as acquisition date for the purpose of assessing long term capital gains?
Based on previous judgments, tax authorities are taking a view that the allotment date is crucial in case of an under construction residential flat and payment is just a follow up action. Therefore, the date of acquisition in an under construction property shall be the date on which the allotment letter is issued by the developer.
7. Can construction of house property start before the date of transfer?
Yes, you can claim exemption under section 54 even if construction of new house had begun before sale of old house provided that other conditions are met.
8. Whether a property purchased in a foreign country is eligible to claim tax benefits under section 54?
As per latest amendment to section 54 and 54 F of Income Tax Act, introduced in Finance Bill 2014, only residential house property purchased in India qualifies for exemption.
9. Whether cost of plot can be included in the cost of residential house property?
Yes, the cost of plot together with the cost of building can be considered as cost of new house property provided the acquisition of plot and construction are both completed within specified periods of these relevant sections of Income Tax Act.
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