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Investing in real estate remains a preferred choice for individuals seeking stable returns while minimizing risk. However, profits from property sales are subject to capital gains tax, which can significantly impact earnings. To provide relief, the Income Tax Act offers various exemptions, one of which is Section 54.

Section 54 allows individuals who sell a residential property to reinvest the proceeds in another residential property and claim exemption on long-term capital gains. This article delves into the eligibility, conditions, and process for claiming benefits under Section 54 of the Income Tax Act.

Understanding Section 54 of the Income Tax Act, 1961

Section 54 grants tax exemption on long-term capital gains from the sale of a residential property, provided the proceeds are reinvested in acquiring or constructing another residential property within the specified timeframe. The exemption is available only for long-term capital gains.

Types of Capital Assets Under Income Tax

Capital assets are categorized based on their holding period:

• Short-term capital assets: Assets held for 36 months or less are considered short-term capital assets. Gains from their sale are termed short-term capital gains (STCG).
• Long-term capital assets: Assets held for more than 36 months qualify as long-term capital assets. Gains from their sale are termed long-term capital gains (LTCG).
• Special conditions:
• Unlisted shares, land, or immovable property held for more than 24 months are classified as long-term capital assets.
• Listed securities, equity-oriented mutual funds, and zero-coupon bonds qualify as long-term capital assets if held for more than 12 months.
• Under Section 54, a residential property must be held for over 24 months to qualify as a long-term capital asset.

Tax Rates for LTCG and STCG (FY 2023-24 vs. FY 2024-25)

The Budget 2024 introduced changes in capital gains taxation, including holding periods and tax rates. Below is a comparison:

Eligibility Criteria for Section 54 Exemption

To avail of benefits under Section 54, the following conditions must be met:

• Only individuals and Hindu Undivided Families (HUFs) can claim the exemption.
• The sold property must be a long-term capital asset and classified as a residential house.
• The new residential property must be purchased within one year before or two years after the sale of the original property. If constructing a new house, the timeline extends to three years.
• The new house must be located in India; properties purchased abroad are ineligible.
• From April 1, 2023, a cap of Rs. 10 crore applies to exemptions under Sections 54 and 54F.

Failure to meet any of these conditions disqualifies the exemption claim.

Calculation of Capital Gain Exemption Under Section 54

The exemption under Section 54 is determined as the lower of:

• The capital gains from the sale of the residential property, or
• The investment made in purchasing or constructing a new residential property.

If the reinvestment is less than the capital gain, the remaining amount is taxable.

Example Calculation:

Mr. Rohan sells his house and earns a capital gain of Rs. 35,00,000. He reinvests Rs. 20,00,000 in a new house. The exemption available under Section 54 is Rs. 20,00,000, and the remaining Rs. 15,00,000 is taxable.

Provisions for Transfer of New Property

If the new property purchased under Section 54 is sold within three years, the exemption previously claimed will be revoked, making the gains taxable. Below are two scenarios:

Case 1: New Property Purchased at a Lower Value Than Capital Gain

If the cost of the new property is less than the capital gains, the entire gain becomes taxable upon sale within three years.

Case 2: New Property Purchased at a Higher Value Than Capital Gain

If the new property costs more than the capital gains, the entire gain is exempted. However, if sold within three years, the exemption is reversed, and gains are taxable.

Capital Gains Account Scheme (CGAS)

If a taxpayer is unable to purchase or construct a property before filing their income tax return, they can deposit the unutilized amount in a Capital Gains Account Scheme (CGAS). This allows them to defer tax liability while still meeting the investment requirement.

Key conditions:

• Deposits must be made in authorized bank branches before the income tax return due date.
• The amount must be used within two years (purchase) or three years (construction).
• If not utilized within the stipulated time, the capital gains become taxable.

Finance Act 2023: Impact on Section 54

The Finance Act 2023 introduced a Rs. 10 crore caps on exemptions under Section 54. If the cost of the new residential property exceeds this limit, the excess investment will not qualify for exemption.

Example:

Mr. Arvind sells a house, earning a capital gain of Rs. 12 crore. He reinvests Rs. 12 crore in a new property. Under the new rule, only Rs. 10 crore is exempt, and the remaining Rs. 2 crore is taxable.

Difference Between Section 54 and Section 54F

Conclusion

Section 54 of the Income Tax Act serves as a beneficial provision for taxpayers looking to reinvest capital gains from a residential property sale into another residential property, thereby minimizing their tax liability. However, strict timelines and eligibility criteria must be adhered to. With the recent cap of Rs. 10 crore, high-value transactions need careful planning.

For NRIs or investors managing multiple properties, consulting a tax expert ensures optimal utilization of available exemptions while staying compliant with tax regulations.

If you have any further questions or need assistance, feel free to reach out to us at admin@ushmaassociates.com or info@nricaservices.com, or contact us via call/WhatsApp at +91 9910075924.

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Disclaimer: Aim of this article is to give basic knowledge about the topic to people who are not in touch with Indian tax norms. When anybody is dealing with these kinds of cases practically, he shall consider all relevant provisions of all applicable Laws like FEMA/Income Tax/RBI /Companies Act etc.