Income Tax

Section 54 of Income Tax Act – Capital Gains Exemption

Capital Gains

Any profit a person makes through the sale of the property is normally taxable under Indian Taxation Laws. It is known as Capital gains. However, under section 54 of the Income Tax Act of 1961[1], one may avail of tax benefits when selling a residential property if one uses the proceeds to buy a new one. It applies to HUFs (Hindu Undivided Families) and qualified individuals. Individuals must implement tax-saving methods that will reduce their tax liability because capital gains tax tends to erode a considerable part of earnings.

Purpose of Section 54 of the Income Tax Act

The sale of a residential property is exempted from capital gains tax under the Income Tax Act Section 54. According to the clause, taxpayers are only eligible for exemption from capital gains if they use the sale property to buy another residential property. Residential property owners frequently sell their homes to buy new ones for a variety of reasons, including job transfers, retirement, and for many other reasons. In this scenario, a taxpayer sells a property not to get profits from the sale’s revenues but rather to change residences. As a result, under Section 54 of the Income Tax Act, a taxpayer is free from capital gain when they sell one residential property and buy another.

Long-Term & Short-Term Capital Gain

A short-term capital gain is any profit from the sale of a short-term capital asset in that an asset held for less than 36 months is referred to as a short-term capital asset. An asset held for a period longer than 36 months is referred to be a long-term capital asset. A long-term capital gain is any profit gained from the sale of a holding long-term capital asset. One of the key requirements for claiming a benefit under section 54 is that the residential property must therefore have been owned by the taxpayer for more than three years after the date of purchase in order to qualify for the capital gains exemption.

Eligibility Under Section 54 to Avail of Exemption

The taxpayer must meet the requirements listed below in order to get the benefits under section 54 of the Income Tax Act:

  • The taxpayer can be an individual or a HUF. Companies, partnership firms, and limited liability partnerships are not eligible for exemption from section 54.
  • The transferred asset must be a residential property, which is a long-term capital asset.
  • within one year before or two years after the date of the transfer of the old property, the taxpayer must either purchase another residential home or should construct the residential house within three years from the transfer of the old property. When a compulsory acquisition is involved, the construction or acquisition time will be calculated starting from the day that compensation is received.
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The exemption is only available in relation to one residential property bought or built in India. If more than one house is bought or built, only one house will be eligible for the exemption under section 54. Regarding a home bought outside of India, no exemption may be requested.

The Finance Act of 2020 amended Section 54 with effect for Assessment Year 2021–2022 to prolong the benefit of exemption in relation to investments made in two residential house properties. If the amount of long-term capital gains is not exceeding Rs. 2 crores, the investment exemption for two residential home properties made through building or acquisition is possible. The assessee will not be permitted to exercise this choice if he exercises this one.

Quantum of Deduction

Capital gains are exempt to the degree that they are used to fund the purchase and/or building of another home, i.e.

  • The entire capital gains shall be excluded if the capital gains amount is the same as or less than the cost of the new house.
  • The cost of the new home shall be allowed an exemption if the amount of capital gain exceeds the cost of the new home.

Capital gain account scheme

Long-term capital gains can be protected through the capital gain account scheme (CGAC) until they can be invested in accordance with section 54 and section 54F. One can invest the LTCG from the sale of immovable property in a residential property under section 54. The LTCG from the sale of shares and bonds may be invested in a residential property under section 54F.

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If a person is unable to invest the money in a home before the income tax return filing deadline, you are permitted to open a CGAS account. To open an account in any of the 28 banks that the government has notified since the scheme’s commencement in 1988. Syndicate Bank, the Central Bank of India, IDBI Bank, Bank of Baroda, Corporation Bank, State Bank of India, and other State Banks that fall under this category. The CGAS facility, however, is not accessible in these Banks’ rural branches.

The Capital gain on the transfer of the original house property is taxable in the year in which it was sold, even though section 54 gives the assessee two years to buy the house property or three years to build the house property. They must submit an application assessment year’s Income Tax Return on or before the deadline. Therefore, the assessee must make a decision regarding the purchase or construction of the residential property by the due date for filing an income tax return, or the capital gain will be taxed.

Suppose the assessee deposits money in the Capital Gain Account Scheme but does not use it to buy or build a home within the required time frame. In that case, the money will be charged as capital gains for the financial year in which the required three years have passed since the original asset was sold. This will be considered a long-term capital gain.

Section 54F

Under the Income Tax Act of 1961, section 54, long-term capital gain on the sale of any capital asset other than the house property is exempted from taxation. Imagine a situation where you sell a capital asset, such as shares, gold, jewellery, bonds, etc., and use the proceeds to buy or build a home. Under section 54F, the returns made from the sale of the capital asset are permitted as a tax deduction. Instead, the profits would become taxable if the sale proceeds were invested in any other asset. The exemption under section 54F is not possible. However, certain predetermined requirements should be met to obtain this tax benefit.

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Transfer of Property After Benefit of Claim

A taxpayer must keep the property for a minimum of three years before claiming any benefit under the Income Tax Act section 54 if they buy or build a new house. The benefit provided under section 54 will be withdrawn if the taxpayer sells the property before the period of three years has passed, and they will also be responsible for any unpaid capital gains from the prior transaction.

Closing of Capital Gain Account 

A person requires permission from the Income Tax Officer under whose jurisdiction he falls in order to shut the account. To get the benefit under section 54, he must also use the money deposited in his capital gains account within two years of the sale of the property. The unutilized money will be liable to capital gain tax in the fiscal year after the deadline if this is not done.

Conclusion

Now it is clear that the individual can be able to avoid paying the taxes on the capital gain after selling a residential property under section 54 of the Income Tax. However, as this law requires, to be eligible for this, one should buy or build a new house property within a certain time frame. The individual can successfully evade paying tax on capital gains once they can do this.

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