Quick Overview
- It offers a tax exemption on long-term capital gains on the sale of a residential house property.
- The exemption is accessible to individuals and Hindu Undivided Families (HUFs).
- The capital gain should be on a long-term residential house property.
- The exemption is permitted when the gains are reinvested in another residential house property in India.
- The purchase of the new property should be made within 1 year prior to or 2 years after the sale.
- In the case of house construction, the construction shall be finished within 3 years after the sale.
- The unutilised capital gains should be deposited under the Capital Gains Account Scheme (CGAS) prior to the actual due date of filing the return.
- The exemption can be reversed, or the new house should not be sold within 3 years.
- The limit on exemption is capped under some monetary limits that have been introduced in more recent amendments.
The sale of a residential property usually leads to capital gains, which are taxable as provided in the Income Tax Act, 1961. Nevertheless, the government offers some exemptions to decrease the tax liability in cases where the proceeds have been invested in another residential house. Section 54 of the Income Tax Act is one of the most significant provisions in this respect.
This step-by-step guide outlines the meaning and application of section 54 of the Income Tax Act, who is entitled to claim it, the circumstances, maximum exemption, and the difference between section 54 of the Income Tax Act and section 54 of the Income Tax Act.
What Is Section 54 of the Income Tax Act?
Section 54 is an Income Tax Act, 1961 tax relief provision of the law that gives the taxpayers an exemption from long-term capital gains tax in circumstances where they sell a residential house and invest the gains in another residential house.
Meaning and Purpose of Section 54
Section 54 of the Income Tax Act is mainly aimed at promoting investment in residential housing. The law does not impose tax on capital gains right away, but rather permits taxpayers to postpone or avoid paying tax on the proceeds as long as they invest the proceeds in a different house property within the specified timeframes.
It assists people in minimising the tax payable and stimulates the development of the housing sector.
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What Is Capital Gain on Sale of Residential Property?
Capital gain is the profit that you make when you sell a residential property at a price above the cost of purchase (including indexation benefits).
Short-Term vs Long-Term Capital Gains
- Short-Term Capital Gain (STCG): IShort-Term Capital Gain (STCG): The gain on the residential property is classified as short-term when the property is sold within a period of 24 months and is taxed as per the applicable income tax bracket. Section 54 is not applicable to short-term capital gains.
- Long-Term Capital Gain (LTCG): When the property is retained over a period exceeding 24 months, it will be considered as long-term capital gain. LTCG is subject to taxation of 20 per cent, including indexation benefits, and this is where Section 54 comes in.
Who Can Claim Exemption Under Section 54 of the Income Tax Act?
Section 54 exemption is only available to:
- Individuals
- Hindu Undivided Families (HUFs)
This exemption cannot be applied to companies, partnership firms and other entities. The taxpayer should have realised long-term capital gains through the disposition of a residential house property.
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Conditions for Claiming Exemption Under Section 54
Certain conditions are required to be met in order to claim exemption under Section 54 of the Income Tax Act.
Eligible Asset Sold
The asset sold must be:
- A residential house property
- Commercial real estate and unoccupied land are ineligible.
Commercial properties and vacant land do not qualify.
Type of New Property Purchased or Constructed
The new asset must be:
- A residential house property
- Located in India
Investment in commercial property does not qualify.
Time Limit for Purchase of New House Property
The taxpayer must purchase the new house:
- Within 1 year before the date of sale, or
- Within 2 years after the date of sale
Time Limit for Construction of New House Property
If constructing a house, the construction must be completed within 3 years from the date of sale of the original property.
Time Limits Prescribed Under Section 54 of the Income Tax Act
Here’s a quick summary of timelines:
- Purchase before sale: 1 year
- Purchase after sale: 2 years
- Construction after sale: 3 years
These timelines are strictly monitored for eligibility.
Amount of Exemption Available Under Section 54
Calculation of Exemption Amount
The exemption is calculated as the lower of:
- Long-term capital gain amount, or
- Amount invested in the new residential property
If the full capital gain is invested, the entire gain becomes exempt.
If only a portion is invested, exemption is allowed proportionately.
Maximum Exemption Limit Allowed
As per recent amendments, the maximum capital gains eligible for exemption under Section 54 is capped at ₹10 crore. Any capital gains above this limit will be taxable.
Capital Gains Exemption Limit on Sale of Residential House Property
If capital gains exceed ₹10 crore, the exemption is restricted to gains up to ₹10 crore. For example, if capital gains are ₹15 crore and ₹15 crore is reinvested, the exemption will still be limited to ₹10 crore.
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What Happens If the New Property Is Sold Within the Specified Time Limit?
If the new property purchased under Section 54 is sold within 3 years:
- The exemption claimed earlier becomes taxable.
- The cost of acquisition of the new property is reduced by the amount of exemption claimed.
- The gain may be treated as a short-term capital gain in certain cases.
Hence, holding the property for at least 3 years is important.
Capital Gains Account Scheme Under Section 54
What Is the Capital Gains Account Scheme?
The Capital Gains Account Scheme (CGAS) allows taxpayers to deposit unutilised capital gains in a designated bank account if they cannot invest the amount before filing their income tax return.
This ensures eligibility for exemption under Section 54 of the Income Tax Act.
When Is Depositing in CGAS Mandatory?
Deposit is mandatory if:
- The capital gains are not fully utilised before the due date of filing the income tax return under Section 139(1).
Failure to deposit may result in loss of exemption.
How to Withdraw Money From the Capital Gains Account
Funds can be withdrawn for:
- Purchase or construction of residential property
The withdrawal must comply with scheme rules and documentation requirements.
Documents Required to Claim Section 54 Exemption
To claim exemption, taxpayers generally need:
- The sale deed of the original property
- Purchase deed of new property
- Capital gains calculation statement
- Proof of payment
- CGAS deposit proof (if applicable)
- Construction agreement (if building property)
Proper documentation is essential during assessment.
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Common Mistakes While Claiming Exemption Under Section 54
Some common errors include:
- Investing in commercial property
- Missing time limits
- Not depositing unutilised funds in CGAS
- Claiming exemption for short-term capital gains
- Selling a new property within 3 years
Avoiding these mistakes ensures smooth claim processing.
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Section 54 vs Section 54F of the Income Tax Act
Many taxpayers confuse sections 54 and 54F of the Income Tax Act. While both offer capital gains exemptions, they apply to different scenarios.
Similarities Between Section 54 and Section 54F
- Both provide exemption on long-term capital gains.
- Both require reinvestment in residential house property in India.
- Both have similar timelines for purchase and construction.
- Both require compliance with CGAS rules.
Differences Between Section 54 and Section 54F
Basis |
Section 54 |
Section 54F |
Asset Sold |
Long-term residential house property (building or land appurtenant thereto) |
Any long-term capital asset other than a residential house (e.g., land, gold, shares, commercial property) |
Nature of Capital Gain |
Long-term capital gain (LTCG) only |
Long-term capital gain (LTCG) only |
Who Can Claim |
Individual or HUF |
Individual or HUF |
Investment Requirement |
Only the capital gains amount needs to be invested |
The entire sale consideration must be invested to claim a full exemption |
Type of New Asset |
One residential house property in India |
One residential house property in India |
Ownership of Other Houses |
No restriction on the number of houses already owned |
The taxpayer must not own more than one residential house (other than the new house) on the date of transfer |
Exemption Calculation |
Lower of capital gains or amount invested |
Proportionate exemption if the entire sale consideration is not invested |
Maximum Exemption Limit |
Capital gains eligible are capped at ₹10 crore |
Capital gains eligible are capped at ₹10 crore |
Time Limits |
Purchase: 1 year before or 2 years after the sale; Construction: within 3 years |
Same as Section 54 |
Deposit in CGAS |
Mandatory if gains are not utilised before the return filing due date |
Mandatory if the sale consideration is not utilised before the return filing due date |
Withdrawal of Exemption |
If a new house is sold within 3 years |
If a new house is sold within 3 years, or the conditions are violated |
Applicable When Selling |
House property |
Land, shares, gold, mutual funds, commercial property, etc. |
Key Points to Remember While Claiming Section 54 Exemption
- Only long-term capital gains qualify.
- The new property must be located in India.
- The maximum exemption limit is ₹10 crore.
- Investment must be within specified timelines.
- Deposit unutilised gains in CGAS before filing the return.
- Do not sell new property within 3 years.
Practical Examples of Section 54 Capital Gains Exemption
Example 1:
Mr A sells a residential house after 5 years and earns LTCG of ₹40 lakh. He purchases another house for ₹45 lakh within 2 years.
Exemption allowed = ₹40 lakh (entire gain exempt).
Example 2:
MMsB sells a house and earns LTCG of ₹50 lakh. She invests ₹30 lakh in a new house.
Exemption allowed = ₹30 lakh.
Taxable LTCG = ₹20 lakh.
Conclusion: Understanding Section 54 of the Income Tax Act
Having learned what section 54 of the Income Tax Act is, it is now evident that the section provides a great tax relief to people who reinvest in residential property. The benefits should be maximised through proper planning, observance of timelines, and documentation requirements.
Although sections 54 and 54f of the Income Tax Act have the same objective, their application varies depending on the nature of the asset sold. The ability to know these differences may assist taxpayers in making sound financial choices and reducing tax liability in a legal manner.
Frequently Asked Questions
Can an exemption under Section 54 be claimed for two house properties?
Yes, a taxpayer can claim an exemption for investment in two residential houses, but only once in a lifetime and if capital gains do not exceed ₹2 crore, subject to conditions prescribed under the Act.
Is the Section 54 exemption available on a joint ownership property?
Yes, if the taxpayer has contributed to the investment and meets eligibility conditions, an exemption can be claimed proportionately.
Can NRIs claim exemption under Section 54 of the Income Tax Act?
Yes, NRIs can claim exemption under Section 54 provided the property sold and purchased are located in India, and other conditions are satisfied.
Is an exemption under Section 54 available if the new house is outside India?
No. The new residential property must be situated in India.
What happens if the capital gains are not fully utilised?
Unutilised gains must be deposited in the Capital Gains Account Scheme before the due date of filing the return. Otherwise, the unused portion becomes taxable.
