Section 54 of the Income Tax Act about Capital Gains Exemption

According to the Indian taxation laws, any profit earned by an individual by property sales is usually taxable. However, Section 54 of the Income Tax Act allows one to avail tax exemptions on selling a residential property by investing the profit for purchasing a new one. It applies to HUFs (Hindu Unified Families) and other eligible individuals.

Are you planning to buy a new house with your capital gains? Then, learn all about the tax exemption you can avail with this section in this article!

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What Is Section 54 of the Income Tax Act?

The process of selling or transferring a capital asset like property comes with taxable capital gains. However, the Government makes it easier for the citizens under Section 54 of the Income Tax Act. According to this, an individual or HUF selling a residential house property can claim exemption from capital gains if they have invested in purchasing or constructing a new residential property. Thus, if you wish to know what deduction under Section 54 is, it mainly applies when taxpayers utilise the capital gains of selling one residential property for purchasing or constructing a new one.

What Is Short Term Capital Gain & Long Term Capital Gain?

As you can see, the capital gains earned from selling or transferring residential property can be exempted from taxation under certain conditions according to Section 54 of the Income Tax Act. However, it is essential to understand the differences between long-term and short-term capital gains in this context.

Profits made by these taxpayers by selling or transferring assets within three years is considered short term capital gains. For shares, such gains apply for about one year of ownership.

On the other hand, long-term capital gains refer to the profits from selling or transferring assets for about three years. The duration of shares or mutual funds should be more than one year. Short-term capital gains have tax rates around 15%, which increases to 20% in terms of long-term capital gains. Assets such as listed securities, units of Equity oriented funds and Zero-coupon bonds are considered long term capital assets.

What Are the Exemptions Allowed Under Section 54 of Income Tax Act?

While learning all about Section 54, a subpart of exemption under Section 10 of the income tax, one needs to identify the kinds of exemptions they might receive in capital gains. Such exemptions will be available to people investing the capital gains in the following conditions.

When the capital gains are used for purchasing another residential property within 1 year before the transfer and within 2 years of transferring the previous property.
When individuals construct a new residential house property within three years from the date of selling the previous property.

The exemption amount following the deduction under Section 54 of the Income Tax Act will be applicable to either the long-term capital gains from selling a property or the amount invested in purchasing a new one, whichever is lower. The balance amount remaining (if any) in the second case will be taxable under this act.

Illustration

Mr. X sells his residential property for ₹ 45,00,000 and the indexed cost of such residential house property assumes 10,00,000. proceeds to purchase a new villa for ₹ 20,00,000. Accordingly, his capital gain will be calculated as follows.

Particulars	Amount
Sale Consideration	₹ 45,00,000.00
Less Indexed Cost of acquisition	₹ 10,00,000.00
Long term Capital gain on selling residential property	₹ 35,00,000.00
Investment made in residential property (Difference)	-₹ 20,00,000.00
Balance – Capital gains	= ₹ 15,00,000.00

According to the exemptions under Section 54 of the Income Tax Act, whichever is lower between the capital gain and the investment in new property, will be exempted from taxation. Therefore, in context to the example given above, the investment made in residential property, that is, ₹ 20,00,000, will be exempted from the taxation.

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Who Is Eligible to Claim Deduction Under Section 54 of the Income Tax Act?

According to the provisions of Section 54 of the Income Tax Act, any individual (taxpayer) selling their residential property and using the capital gain to purchase new property is eligible for a tax exemption. However, a taxpayer should qualify for the following eligibility criteria for a tax exemption.

The applicants include only individuals or HUF, and no other organisations will be eligible for this exemption.
Moreover, the property should be a residential one.
A house property in sale should be a long term capital asset.
One should buy a new residential property either a year before the transfer or two years after the sale or constructed within 3 years from the date of transfer
The house property should be sold and bought in India.

What Are the Provisions Relating to the Transfer of Property After Claiming Benefit Under Section 54?

While this section and its exemption rules might sound simple, several regulations link with it. For example, suppose you aim to avail exemption under Section 10 of the Income Tax Act through Section 54. In that case, you need to fulfil the following mandatory conditions while transferring your property after claiming the exemption benefits.

You should purchase a new residential property or construct a new house property immediately after selling your old residential property.
Further, you should be either buying your new residential property one year before selling the old property, two years after its sale or constructed within three years of the sale.
You can only claim this exemption benefit against one house property.
Suppose you fail to construct or purchase new property before the due date of filing return of income. In that case, you will have to deposit the amount under the Capital Gains Account Scheme in any public sector bank to avail of this exemption

What Is Capital Gains Account Scheme?

An essential aspect of utilising these benefits of income tax exemption under Section 10 through Section 54 links with the Capital Gains Account Scheme. This section has set some mandatory dates for purchasing a new property and thereby utilise its benefits.

However, suppose you fail to buy or construct property before the due date and still wish to avail of the exemption. In that case, you can invest your capital gain proceeds of the old house property in Capital Gains Deposit Scheme. You can open such an account from any authorised/approved bank branch.

For opening a CGAS, you need to deposit before the due date of filing income tax returns. Moreover, you need to utilise the deposited amount to purchase or construct the house as this section provides. You can transfer this amount to your CGAS to build a new home within 2 or 3 years. However, your capital gain will become taxable if you fail to do so within this period.

Now you know that Section 54 of the Income Tax Act can help you avoid taxation of your capital gains after selling a housing property. However, to receive this, you should be able to purchase or construct a new housing property within a stipulated period as required by this law. Once you can do this, you can successfully avoid paying tax on your capital gains.

FAQs about Section 54 of Income Tax Act

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What happens if I don't declare capital gains?

Concealment of Income leads to significant penalties under the Indian Income Tax Act. Moreover, the Income Tax Forms come prefilled with capital gain transaction data from FY 2020-21.

Which banks have a Capital Gain Account Scheme?

Any authorised banks under the Indian Government, including Central Bank of India, State Bank of India, Syndicate Bank, IDBI Bank, Bank of Baroda and Corporation Bank, can assist you with a CGAS.