Section 54 of Income Tax Act

Section 54 of the Income Tax Act provides the seller of a residential property with relief from capital gains tax. The section allows taxpayers to obtain relief from capital gains tax only if the proceeds from the sale are used to acquire another residential property. Owners of residential property in many cases sell their property only to purchase another property due to various reasons like moving from jobs, retirement, and so on. In such a case, a property is sold by a taxpayer not for gains from the proceeds, but for the purpose of changing the residence. Hence, when a taxpayer sells a residential property and purchases another property, the taxpayer is exempt from capital gains under Section 54 of the Income Tax Act.

Eligibility under Section 54 of the Income Tax Act

The following conditions must be satisfied by the taxpayer to claim benefits under Section 54 of the Income Tax Act:

The taxpayer is an individual or HUF. Exemption under Section 54 is not available for companies, partnership firms or Limited Liability Partnerships.
The asset transferred should be a long-term capital asset, which is a residential house property.
Within a period of one year before or two years after the date of transfer of the old house, the taxpayer should acquire another residential house or should construct a residential house within a period of three years from the date of transfer of the old house. In the case of compulsory acquisition, the period of acquisition or construction will be determined from the date of receipt of compensation (whether original or additional).

A taxpayer can claim benefit under Section 54 of the Income Tax Act for one residential house property purchased or constructed in India only. If a taxpayer is involved in more than one such transaction during the lifetime of the concerned individual, the benefit will be available for one of the transaction only. Finally, a taxpayer cannot sell a home in India and buy a home abroad, while claiming benefit under Section 54. The home purchased or constructed must be in India only.

Long Term vs Short Term Capital Gains

A short-term capital asset is an asset which is held not more than 36 months or less. Any gain from selling a short-term capital asset is termed as a short-term capital gain. A long-term capital asset is an asset which is held for more than 36 months. Any gain from selling a long-term capital asset is termed as a long-term capital gain. To claim benefit under Section 54, one of the important criteria is that the residential property is a long-term capital asset. Hence, to claim capital gains exemption, the property must have been held by the taxpayer for a period of more than 3 years from the date of purchase.

Transfer of Property After Claiming Benefit under Section 54

Further, if a taxpayer claims any benefit under Section 54 of the Income Tax Act and purchases or constructs a new house, it is necessary to hold that property for a minimum period of three years. If the taxpayer sells the property before the end of three years, then the benefit granted under Section 54 will be withdrawn and the taxpayer would have to pay the capital gains due on the previous transaction.

Amount of Exemption

The amount of capital gains exemption under Section 54 of the Income Tax Act will be the lower of:

Amount of capital gains arising on transfer of the residential house.
Investments made in the purchase or construction of a new residential house property.

Capital Gains Deposit Account Scheme

Under Section 54 of the Income Tax Act, a taxpayer having long-term capital gains from the sale of a residential property can avoid the same by purchasing or constructing a residential property one year before or two years after (in case of purchase of property) or before three years (in case of construction of property). In some cases, the proceeds from the sale of the residential property would not have been invested by the taxpayer at the time of filing of income tax returns. In such cases, the capital gains benefit under Section 54 can be availed by depositing the unutilized amount in Capital Gains Deposit Account Scheme in any branch of public sector bank. The new house can later be purchased or constructed by withdrawing the deposits from the account within a time frame of two or three years. If the deposits are not utilized within the stipulated period for the purpose of purchase or construction, the amount deposited will be taxable.