Decoding Sections 54 and 54F of the Income Tax Act, 1961

People might buy capital assets to ensure present and future financial security, be independent in any event of financial hardship or create a source of funds for their future financial goals. But, when they sell these capital assets, the profit that they earn from such a sale is called a capital gain. Such a gain is chargeable to tax under the Income Tax Act, 1961. However, certain provisions of the Income-tax law allow taxpayers to claim specific exemptions against such gains, which help them reduce their tax liability. So, are you wondering how to save capital gain tax? You can save tax on your capital gains by availing the benefit of the provisions of two important sections of the Act,which are sections 54 and 54F.

Let’s look at what these sections are all about by giving a read to this article.

1: Exemption under Section 54

As per Section 54 of the Income-tax Act, an individual or HUF can avail tax exemptions on long-term capital gains arising on transfer of a residential house property if the amount of such capital gains is invested in purchasing or constructing another residential house property.

The primary conditions that need to be satisfied to avail the benefit of this section are as follows:

* The exemption under 54 is available only to an individual or HUF. Taxpayers such as partnership firms, LLPs, companies, AOPs or BOIs cannot claim relief under this section.

* The transferred asset should be a long-term capital asset, being a residential house property.

* Income (if any) from such transferred residential house should be chargeable under the head 'Income from House Property’.

* The seller should, within one year before or two years after the date on which the transfer took place, purchase, or within three years after that date, construct one residential house.

* The new residential house property should be in India. The taxpayer cannot purchase or construct a residential house abroad and claim the exemption under this section.

The conditions mentioned above are cumulative. Hence, even if one requirement is not fulfilled, the assessee will not be able to claim the benefit of the exemption u/s 54.
With effect from AY 2021-22, section 54 has been amended to extend the relief of exemption for the investment made in two residential house properties in India. The exemption for the investment made to purchase or construct two residential house properties shall be available only if long-term capital gains do not exceed Rs. 2 crores. It must be noted that once the taxpayer avails of this option, he shall not be eligible to exercise it again for the same or any other assessment year.

Amount of Exemption

A taxpayer can avail exemption on long-term capital gains of an amount lower of the following:

* Capital gains arising on transfer of the long-term residential house property; or

* Amount invested in purchasing or constructing new residential house property.

Restriction on Transfer of the New Residential House Property

The government has inserted a restriction in section 54 to ensure that the new house property purchased to claim the exemption under this section is retained for a particular period, and the provisions thereof are not taken undue advantage of. The restriction is in the form of prohibition on the sale of the new house property within three years from the date of its purchase or construction, as the case may be.

If the exemption is claimed under section 54 and the new house is sold within three years from its purchase or construction, then at the time of computation of capital gain arising on transfer of such new house, the amount of exemption claimed on capital gains u/s 54 will be subtracted from the cost of acquisition/construction of the new house. Consequently, the cost of acquisition/construction of the new house property will decrease or become nil, as the case may be, resulting in higher capital gains on the transfer of such property.

Let us have a look at the below illustrations to have a better understanding of the provisions of section 54:

Illustration 1

Mr. Verma purchased a residential house in May, 2015 and sold the same in May, 2021 for Rs.7,45,000. He made a capital gain of Rs.1,50,000 on such sale. Can he avail the benefit of section 54 by purchasing/constructing another residential house from the capital gain of Rs.1,50,000?

Ans. Exemption u/s 54 can be claimed in respect of capital gains arising on transfer of a capital asset, being a long-term residential house property. This relief is available only to an individual or HUF. In this case, all the conditions provided in section 54 are satisfied. Hence, Mr. Verma can claim the benefit of section 54 by purchasing/constructing a residential house within the time limit as provided under section 54 (mentioned above). 

Illustration 2

Mr. Kapoor purchased gold in June, 2016 and sold the same in August, 2021 for Rs.8,90,000. Capital gain arising on the transfer of gold amounted to Rs.1,30,000. Can he claim the exemption u/s 54 by purchasing/constructing a house from the capital gain of Rs.1,30,000?

Ans. Exemption u/s 54 can be claimed on capital gains arising on transfer of a capital asset, being long-term residential house property. In this example, since the capital asset is gold, i.e., other than a residential house, the exemption of section 54 is not available. However, in this case, the benefit can be claimed under section 54F subject to certain conditions defined in that provision (Discussed in subsequent paragraphs).

Illustration 3

Mr. Goyal purchased a residential house in October, 2021 and sold the same in May, 2022 for Rs.9,40,000. Capital gain arising on such sale amounted to Rs.3,50,000. Can he claim the exemption under section 54 by purchasing/constructing another residential house from the capital gain of Rs.3,50,000?

Ans. Exemption u/s 54 can be claimed on capital gains arising on transfer of a capital asset, being long-term residential house property. An immovable property qualifies as a long-term capital asset if its holding period exceeds 24 months. In this case, the house property is transferred after holding it for less than 24 months and, therefore, it is a short-term capital asset. The benefit of section 54 cannot be availed in respect of a short-term capital asset, and, thus, in this case, Mr. Goyal cannot claim the benefit of section 54.

2: Exemption under Section 54F

As per section 54F of the Income-tax Act, an individual or HUF can avail tax exemptions on capital gains on transfer of a long-term capital asset other than a residential house if the amount of such capital gains is invested in purchasing or constructing a residential house property in India.

The basic conditions that need to be satisfied to avail the benefit of section 54F are as follows:

* The exemption under 54F is available only to an individual or HUF.

* The exemption is available on the capital gains arising on the transfer of any long-term capital asset other than a residential house property.

* The taxpayer should invest the net consideration received on transfer of the original asset in either of the following:

* To purchase one residential house in India within a period of one year before or two years after the date of transfer of the original asset.

* To construct one residential house in India within three years after the date of transfer took place.

For this section, the ‘net consideration’ in respect to the transfer of a capital asset means the total value of the consideration received or accruing in relation to the transfer of the capital asset as reduced by any expenses incurred exclusively in connection with such transfer.

Amount of Exemption

Case 1: Cost of the new asset exceeds the net consideration in respect of the original asset

If the cost of purchasing or constructing the new asset is more than the net consideration received or accrued in relation to the transfer of the original asset, the whole amount of capital gain shall be exempted under section 54F.

Case 2: Cost of the new asset is less than the net consideration in respect of the original asset

In case the entire sale consideration is not invested in the new asset, i.e., if the cost of the new asset is lower than the net consideration in relation to the original asset, then exemption shall be allowed proportionately in the following manner:

Amount of exemption = Long-term capital gain * (Amount invested in the new asset/Net sale consideration)

Circumstances in which Exemption u/s 54F is not Available

The circumstances in which the exemption u/s 54F is not allowed are as follows:

* The taxpayer has more than one residential house, other than the new asset, on the date of transfer of the original asset.

* The taxpayer purchases any residential house, other than the new asset, within one year after the date of transfer of the original asset, and the income from such residential house is chargeable under the head 'Income from house property’.

* The taxpayer constructs any residential house, other than the new asset, within three years after the date of transfer of the original asset, the income from which is chargeable under the head 'Income from house property’.

In case of the taxpayer purchases, within two years after the date of the transfer of the original asset, or constructs, within three years after such date, any residential house, the income from which is chargeable as 'Income from house property’, other than the new asset, the amount of capital gain on transfer of the original asset that was exempted u/s 54F shall be charged as long-term capital gains in the financial year in which such residential house is purchased or constructed.

Restriction on Transfer of the New Residential House Property

As in the case of section 54, the similar lock-in period of three years on the transfer of the new residential house from the date of purchase or construction, as the case may be, is applicable u/s 54F also.

If the exemption is claimed under section 54F and the new house is transferred within three years from the date of its purchase/construction, the amount of capital gain arising from the transfer of the original asset exempted in the year of such transfer shall be charged as long-term capital gains of the financial year in which such new asset is transferred.

Note: For section 54F, if the assessee owns more than one residential apartment or residential unit in the same building on the date of transfer of the asset, it will be treated as one residential house property only. This view has been constructed by placing reliance on the following case judgements:

1. SHRI. NAVIN JOLLY C/O NAVIN ARCHITECT PRIVATE LIMITED VERSUS THE INCOME-TAX OFFICER, WARD 11 (1) [2020] 424 ITR 462 (Kar)

It was held that “The assessee even otherwise is entitled to the benefit of exemption under Section 54F(1) of the Act as the assessee owns two apartments of 500 square feet in the same building and therefore, it has to be treated as one residential unit”.

2. SRI S.M. VINOD, L/R OF LATE SM MUNIYAPPA VERSUS THE INCOME TAX OFFICER, WARD 7 (2) (1), BANGALORE [ITA No.192/Bang/2020 (Assessment year: 2016-17)]

It was held that “The assessee owns one independent building which has two units one in the ground floor and another in the first floor and having two units cannot change the nature of the building, it remains as “one residential house” as in the case of Shri Ramaiah Harish [2021 (9) TMI 1138 - ITAT BANGALORE]. Thus, we direct the AO to allow deduction u/s. 54F of the Act. The grounds raised by the assessee are allowed.”

Now that we have gone through the provisions of section 54F, let us have a look at the below illustrations to understand the section better:

Illustration 1

Mr. Sharma purchased a residential house in March, 2016 and sold the same in May, 2021 for Rs.7,50,000. Capital gain on sale of the house property amounted to Rs.2,50,000. Can he claim the benefit of section 54F by purchasing/constructing a house from the capital gain of Rs.2,50,000?

Ans. Exemption under section 54F can be claimed in respect of capital gains arising on transfer of a long-term capital asset, not being a residential house property. In this case, since the capital asset is house property, the benefit of section 54F will not be available.

Illustration 2

Mr. Jain sold a long-term capital asset, other than a residential house property, for Rs. 60 lakhs and made a capital gain of Rs. 6 lakhs. He invested the entire amount of Rs. 60 lakhs to purchase a house property in India. He owns only one house on the date of sale of the asset. Calculate the amount of capital gain that would be exempt under section 54F.

Ans. Since Mr. Jain has invested the whole amount of capital gains in purchasing the new house and satisfies all the required conditions to claim the exemption, he can claim the entire amount of long-term capital gain, i.e., Rs. 6 lakhs, as exemption under section 54F.

Illustration 3

In illustration 2 above, assume that Mr. Jain invested only Rs. 35 lakhs towards the purchase of the house property. Now, calculate the amount of exemption on capital gains that he can claim u/s 54F.
Ans. Since, in this case, the amount invested in the new asset is less than the net sale consideration, the exemption would be calculated as follows –

Amount of exemption = Long-term capital gain * (Amount invested in the new asset/Net sale consideration)

= 6 lakhs * 35 lakhs/60 lakhs
= Rs. 3.5 lakhs

Hence, in this case, Mr. Jain can claim the exemption of Rs. 3.5 lakhs under section 54F.

Concept of Capital Gains Account Scheme

As mentioned above, to claim benefits under sections 54 and 54F, the taxpayer must purchase a residential house within a period of one year before or two years after the date of transfer of the long-term capital asset or should construct the same within three years from the date of transfer. If till the date of filing the Income-tax return, the capital gain, in case of section 54, and net consideration, in case of section 54F, on the transfer of the original asset, is not utilised (in whole or part) to purchase or construct the new house property, then the benefit of exemption can be claimed by depositing such unutilised sum in Capital Gains Deposit Account Scheme. The new house property can be purchased or constructed by withdrawing the amount from the said account within the specified time limit of two years or three years, as the case may be.

Unutilised amount in Capital Gain Account Scheme

If the sum deposited in the Capital Gains Deposit Account Scheme in respect of which the assessee has claimed exemption under section 54 or 54F is not utilised within the specified period for purchasing or constructing the residential house, then the unutilised amount will be taxed as long-term capital gains in the year in which the specified period of three years from the date of transfer of the original asset gets over.

Similarities between sections 54 and 54F

There are several common provisions under section 54 and section 54F that are as follows:

* A new residential house property must be purchased or constructed to claim the exemption.

* The new residential house property must be purchased within one year before or two years after the transfer of the original asset.

* Alternatively, the new residential house property must be constructed within three years from the date of transfer of the original asset.

* Both the sections state a similar lock-in period of three years for transfer of the new asset from the date of purchase or construction of the original asset, as the case may be.

* The option of depositing the unutilised amount of capital gains in the Capital Gains Account Scheme is available under both sections.

Section 54 v/s Section 54F

Section 54 and section 54F differ in various aspects, some of which are as follows:

* The main difference lies in the asset on which the exemption is available under each section. The exemption u/s 54 is available on long-term capital gain on the transfer of a residential house property. Whereas, under section 54F, the exemption is available on long-term capital gain on the transfer of any asset other than a residential house property.

* To claim full exemption u/s 54, the entire capital gains must be invested in the new asset. In contrast, the total net consideration must be invested in the new asset to claim full exemption under section 54F.

* Once in a lifetime option is available of claiming exemption on capital gains under section 54 on investing such gain in two properties if the amount of capital gains does not exceed Rs. 2 crores. No such option of investment in two assets is available u/s 54F.

* The taxpayer should not own more than one residential house, other than the new asset, on the date of transfer of the original asset to claim exemption u/s 54F. There is no such restriction stated in section 54.

* In case the entire capital gains are not invested in the new asset, then u/s 54, the invested amount is exempted, and the remaining amount is charged to tax as long-term capital gains. Whereas, u/s 54F, if the entire net consideration is not invested, the exemption is allowed proportionately (explained in the above paragraphs).

Summing up

After reading this blog, it can be concluded that if the sale and purchase of capital assets are planned keeping in mind the provisions of sections 54 and 54F, a taxpayer (individual & HUF) can save a considerable amount of taxes. Hence, the taxpayers must carefully understand these provisions and plan their investments in such a way so that they are able to reap the benefits of the relief provided under the said sections. If the taxpayers face difficulty on how to compute capital gain tax or have confusion in calculating capital gain exemption on sale of house property or any other capital asset, they should consider consulting a capital gain tax expert who can provide them with the correct guidance.

In conclusion, capital gains earned from the sale of capital assets are taxable under the Income Tax Act. However, taxpayers can reduce their tax liability by taking advantage of exemptions provided under sections 54 and 54F. Section 54 allows for exemptions on the sale of a residential house property, while section 54F provides exemptions on the sale of other long-term capital assets. By understanding the conditions and requirements of these sections, individuals and HUFs can effectively save on capital gains tax and achieve their financial goals.

Ready to Save Capital Gain Tax? Explore Sections 54 and 54F to avail tax exemptions on your capital gains. Mail us at info@manishanilgupta.com to learn more!

Disclaimer: The information given above by the author is to provide general guidance to the readers. This information should not be sought as a substitute for legal opinion