While many people purchase property to change homes, others view it as an investment avenue. Some homeowners buy and sell properties to earn a profit based on market fluctuations. However, the profit earned from selling a property – known as capital gains – is subject to taxation, making property transactions a closely scrutinised process.

At times, people sell their homes while changing jobs, retiring, or shifting to a new place due to a job transfer. In these cases, capital gains tax can add an unwelcome financial burden, especially when purchasing a new property. Fortunately, Section 54 of the Income Tax Act, 1961, provides relief by offering capital gains tax exemptions under specific conditions.

In this article, we will explore Section 54 in detail, covering all the essential aspects to help you make the most of its advantages when selling a property.

What Is Section 54 of the Income Tax Act?

Section 54 of the Income Tax Act provides a capital gains tax exemption for individuals and Hindu Undivided Families (HUFs) on the sale of residential property. This exemption applies if the proceeds from the sale are reinvested in purchasing or constructing another residential property within the prescribed timeline.

To qualify, the seller must purchase a residential property either within one year before or two years after the date of sale/transfer. If opting for construction, the new residential property must be built within three years from the date of sale/transfer. Additionally, the new property must be located in India.

Further, partnership firms, organisations, LLPs, or similar bodies cannot get a deduction under Section 54.

Purpose of Section 54 of the Income Tax Act

Investing in real estate has long been considered a stable and relatively low-risk strategy. Many investors with a low-risk tolerance prefer to buy property and sell it later for a higher return. However, they often overlook the taxation aspect of such transactions.

Under Section 2(14) of the Income Tax Act, a capital asset, including real estate, is subject to taxation. However, only the capital gains – the profit earned from selling the property – are taxable, not the entire sale proceeds.

The primary purpose of Section 54 is to provide tax relief to homeowners by offering exemptions on long-term capital gains when the proceeds are reinvested in another residential property. This provision also encourages asset reinvestment in the real estate sector.

Documents Needed for Section 54 Exemption

Commonly required documents include:

• Sale deed of the original property for proof of sale.
• Purchase deed of the new property for evidence of constructing a new residential property.
• Completion certificate for under-construction properties.
• Bank statements showing payment details related to the new property purchase.
• Form 10BA.

What Is a Capital Asset?

A capital asset refers to any property owned by an individual or business for personal or professional use. It includes land, buildings, houses, stocks, bonds, mutual funds, jewellery, leasehold rights and trademarks. However, items like raw materials for business purposes, stock-in-trade, and personal goods (except jewellery, paintings, or art pieces) are not considered capital assets.

What Are the Different Types of Capital Assets Under Income Tax?

Under the Income Tax Act, capital assets are categorised based on their holding period into short-term and long-term capital assets.

Short-Term Capital Assets  

A capital asset held for not more than 24 months (or 36 months if transferred before 23-07-2024) before the date of transfer is classified as a short-term capital asset. However, certain assets are considered short-term if held for not more than 12 months, such as equity or preference shares listed on a recognised stock exchange in India and Zero Coupon Bonds.    

Long-Term Capital Assets

A long-term capital asset is any capital asset held for more than 24 months (or 36 months if transferred before 23-07-2024) before the date of transfer. In certain cases, assets held for more than 12 months are also considered long-term capital assets based on specific provisions.

Who Is Eligible to Avail of the Benefits Under Section 54?  

To claim benefits under Section 54 of the Income Tax Act, the following conditions must be met:

• The seller must be an individual or a Hindu Undivided Family (HUF).
• The residential property being sold must be located in India.
• The capital gains from the sale must be reinvested in purchasing or constructing a new residential property within the prescribed timelines discussed earlier.
• The sold residential property must be classified as a long-term capital asset and its income should have been taxable under the "Income from House Property" category.

Exemption Amount Available Under Section 54 of the Income Tax Act

Under Section 54 the amount of exemption for long-term capital gains is determined based on the lower of: 

• The capital gains arising from the sale of a residential property.
• The amount reinvested in purchasing or constructing a new residential property.

Any remaining capital gains after the exemption will be subject to taxation.
For example, Mr. A sells his house for INR 50 lakhs and reinvests INR 30 lakhs in purchasing a new property. The capital gains are calculated as follows:

• Capital Gain from the Sale: INR 50 lakhs
• Investment in New Residential Property: INR 30 lakhs
• Taxable Capital Gains After Exemption: INR 20 lakhs

Since the exemption is the lower of capital gains (INR 50 lakhs) or investment in the new property (INR 30 lakhs), Mr. A can claim an exemption of INR 30 lakhs, and the remaining INR 20 lakhs will be taxable.

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

If a house purchased using the Section 54 exemption is sold within three years of acquisition, the previously exempted capital gains will become taxable in the year of sale. This means the exemption will be revoked, and the amount will be added to the capital gains for that year, making it subject to taxation.

Let’s examine two scenarios:

Case 1: A new property costs less than the capital gains from the original property sale

Suppose Rahul sold a house in 2018, with capital gains of INR 50 lakhs. In the same year, he bought a new house for INR 35 lakhs. Later, Rahul sold this new house in 2019 for INR 55 lakhs.

In the financial year 2018-19 (original property sold in 2018):

• Capital Gains from Sale: INR 50 lakhs
• Less: Investment in New Property: INR 35 lakhs
• Taxable Capital Gains: INR 15 lakhs

In the financial year 2019-20 (new property sold in 2019):

• Sale Consideration: INR 55 lakh
• Less: Cost of Acquisition (considered NIL due to early sale): INR 0
• Taxable Capital Gains: INR 55 lakhs

Since Rahul sold the new property within 36 months, its cost of acquisition is treated as NIL, resulting in a higher taxable capital gain.

Case 2: A new property costs more than the capital gains from the original property sale

Suppose Neha sold a house in 2018, earning capital gains of INR 30 lakhs. In the same year, she purchased a new property for INR 45 lakhs. Later, Neha sold this new house for INR 60 lakhs in 2020.

Taxable Capital Gains Calculation:
In the financial year 2018-19 (original property sold in 2018):

• Capital Gains from Sale: INR 30 lakhs
• Investment in New Property: INR 45 lakhs
• Taxable Capital Gains: NIL

In the financial year 2020-21 (new property sold in 2020)

• Sale Consideration: INR 60 lakhs
• Less: Cost of Acquisition (as per working note): INR 15 lakhs
• Taxable Capital Gains: INR 45 lakhs

Working Note (Cost of Acquisition Calculation):
Since Neha sold the new house within 3 years and had earlier claimed exemption under Section 54, the cost of acquisition is adjusted as follows:

• Original Purchase Price of New House: INR 45 lakhs
• Less: Capital Gains Exempted from Earlier Property Sale: INR 30 lakhs
• Considered Cost of Acquisition: INR 15 lakhs

Thus, as the new property was sold within 3 years, only INR 15 lakhs is considered as the cost of acquisition, resulting in a higher taxable capital gain of INR 45 lakhs.

Section 54 v/s Section 54F 

Section 54 is associated with long-term capital gains earned from selling a residential property. However, Section 54F applies to long-term capital gains earned from selling any capital asset other than a residential property.

Under Section 54, taxpayers can claim an exemption for up to two residential properties in India (once in a lifetime) if the capital gains do not exceed INR 2 crore, but Section 54F does not allow this option.

Another key difference is in the investment criteria. Section 54 allows exemption only on the indexed long-term capital gains, while Section 54F exemption is possible when the entire net consideration from the asset’s sale is reinvested.

Common Requirements Between the Two Sections

Let's look at the common requirements between Section 54 and 54F of the Income Tax Act.

• To qualify for the exemption, the capital gains (in the case of Section 54) or the entire net sale proceeds (in the case of Section 54F) must be reinvested in buying or constructing a new residential property.
• The new property must be purchased within two years after the sale or one year before the sale of the original property.
• If constructing a new residential property, the construction must be completed within three years of selling the original asset.
• If the reinvestment is not made before the tax filing deadline (or within one year from the sale date), the amount can be deposited in a public sector bank or other banks under the Capital Gains Account Scheme (CGAS).

The table below explains the difference between Section 54 and 54F.

Read More:- Section 24 - Income Tax Deductions from Property House

What are the Provisions Relating to the Transfer of Property after Claiming Benefit Under Section 54?

As we discussed earlier, the amount of money you gain when you sell a property is referred to as capital gains. Think of an instance where you sell a house you bought by claiming the exemption under Section 54 within three years of purchase. In this case, the amount claimed through exemption will be indirectly liable for taxes in the year of the sale of the new property.

Let us consider two examples for this case:

Case 1: Cost of a new house is Less than the capital gain from the original sale

Suppose Aman sold a house in 2015 with capital gains of INR 40 lakh. In the same year, he purchased a new house for INR 27 lakh. Aman sold the new house in 2016 for INR 43 lakh.

Taxable Capital Gains Calculation:
In the financial year 2015-16 (property sold in 2015):
Amount of Capital Gains: INR 40 Lakhs
Less: Investment in new property: INR 27 Lakhs
Amount of Taxable Capital Gains: INR 13 Lakhs

In the financial year 2016-17 (new property sold in 2016):
Amount for Sale Consideration: INR 43 Lakhs
Less: Cost of Acquisition (considered as NIL): INR 0
Amount of Taxable Capital Gains: INR 43 Lakhs

Since the new property was sold within 36 months, its cost of acquisition was considered NIL, leading to higher taxable capital gains.

Case 2: Cost of a new house is more than the capital gains from the original sale

Let us suppose Arti sold a house in 2015 with capital gains of INR 30 lakh. In 2015 itself, she purchased a new house for INR 40 lakh. Arti sold the new house in 2017 for INR 55 lakh.

Taxable Capital Gains Calculation:
In the financial year 2015-16 (property sold in 2015):
Amount of Capital Gains: INR 30 Lakhs
Less: Investment in new property: INR 45 Lakhs
Amount of Taxable Capital Gains: NIL

In the financial year 2016-17 (new property sold in January 2017):
Sale Consideration: INR 55 Lakhs
Less: Cost of Acquisition (considered as per working note): INR 15 Lakhs
Amount of Taxable Capital Gains: INR 45 Lakhs

To compute the cost of acquisition since the property was sold within 3 years of purchase and since Section 54 was claimed:
Cost of Acquisition: INR 45 Lakhs
Less: Capital gains claimed for earlier house property: INR 30 Lakhs
Cost of the new house (considered): INR 15 Lakhs

Section 54 v/s Section 54F

Section 54 is applicable to long-term capital gains on the sale of a residential property, but Section 54F applies to long-term capital gains on the sale of any asset other than the residential property. In Section 54, there is an option to avail of this exemption on two properties at a time. There is no such exemption in Section 54F.

While Section 54F is possible if the net consideration of such assets is invested, Section 54 allows you to invest only the indexed long-term capital gains. Under Section 54F, you should not own more than one residential property as of the date of the asset's sale, in addition to the one that is bought or built to be eligible for the exemption. Section 54 does not have any such requirements.

Common Requirements Between the Two Sections

Section 54 and 54F of the Income Tax Act are two very commonly confused terms in the world of taxation. Before discussing the difference between these two, let us have a look at the common requirements needed to avail of any of the two sections.

• To receive the exemption, you must acquire or construct a new residential housing property.
• The replacement residential property needs to be bought either two years after the asset or property is sold or one year before it is sold.
• Alternatively, the new property needs to be built within three years of the asset or property being sold.
• In case you are unable to invest the specified amount in the way described above before the date of tax filing or one year from the date of sale, whichever occurs first, you can deposit the specified amount in a public sector bank.
• You can only buy or build one residential property. Section 54 of Income Tax Act provides a once-in-a-lifetime benefit of exemption on two properties for capital gains up to INR 2 crore.

The difference between Section 54 and Section 54F is given below:

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Latest News on Section 54 of the Income Tax Act

Effective April 1, 2024, the maximum exemption under Section 54 is limited to INR 10 crore. This means that if the purchase price of the new residential property exceeds INR 10 crore, any amount beyond this limit will not be eligible for exemption.

Conclusion

Section 54 of the Income Tax Act helps individuals selling their homes reduce their tax burden on capital gains. This exemption eases the financial strain of selling a property and reinvesting in a new one, making homeownership more affordable.
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