Section 54 of Income Tax Act - Purpose, Benefits, Exemption, Provision

Selling and buying property has always been a topic of scrutiny in the taxation process. While many people buy a property as a part of their investment and later resell it to gain profit, there are others who wish to change their address of residency to a new place. The sale of properties is subject to capital gain tax, where the amount of profit earned for selling the property is subject to taxation.

For people who are selling their property due to retirement, transfer, change of employment, etc., capital gain tax turns out to be an unnecessary blow to the expenses of buying a new house. This is where Section 54 of the Income Tax Act comes to your rescue. We will discuss Section 54 more explicitly in this article, covering all the necessary details to make sure that you get the complete benefits of this act in case you’re selling a property.

Latest News on Section 54 of Income Tax

Like any other act, Section 54 of the Income Tax Act underwent a few changes due to the new interim budget. The most recent change in Sections 54 and 54F includes a deduction on long-term capital gain tax for reinvestment in residential properties.

The deduction limit has been set to 10 crores, which means that any property above 10 crores will not be liable to make use of Sections 54 and 54F. The recent change in the deduction limit has been done with the intent of increasing house-building activities.

What is Section 54 of Income Tax Act?

Section 54 of the Income Tax Act is a special exemption offered on capital gain tax. Under this exemption, individuals and HUFs (Hindu undivided families) can claim exemptions from capital gains while selling their property if they wish to purchase or construct another residential property using the selling amount. This exemption is applicable if the amount from the sold residential property is used for the purpose of acquiring a new residential property.

Purpose of Section 54 of Income Tax Act

For people who are looking for a stable, risk-free, and secured investment, investing in properties seems to be the best option. It has been an age-old practice where people buy a property and resell it for higher rates. While planning this sort of investment, most people forget about the taxation part.

According to Section 2(14) of the Income Tax Act, any type of asset, including property, is subjected to taxation. The question here is whether the whole amount of the reselling is subject to taxation. The answer is no, since only the profit earned through reselling is taxable.

But in many cases, the property being sold is being used for genuine purposes, like buying a new residential property. This is where Section 54 of the Income Tax Act helps individuals. It provides relief from the tax applicable to the profit.

What is a Capital Asset?

Properties that you own and have the ability to transfer, such as real estate, buildings, stocks, jewels, patents, trademarks, equipment, automobiles, and leasehold rights, are referred to as capital assets. It is specified under Section 2(14) of the Income Tax Act.

Anything that an individual owns for any reason, including physical, intangible, moveable, and immovable things, is included in capital assets. It does not matter if the object is for personal or professional use. It will still be included in capital assets.

Must Read:- What Is Property Tax And How Is It Calculated?

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

According to the Income Tax Act, assets are divided into various categories for capital gains purposes based on how long they have been owned. Accordingly, capital assets have been categorized into two types according to the time frame during which they are sold. Given below are brief descriptions of the two types.

Short-term Capital Assets

An asset is considered a short-term capital asset if it is sold during the holding period of 36 months of ownership. There are a few exceptions to this rule. For example, the holding period would only be 24 months if the asset were an immovable property, such as a building, home, or plot of land. Additionally, the holding period extends to 12 months for zero-coupon bonds, equity-oriented mutual fund units, etc.

Long-term Capital Assets

Assets classified as long-term capital are ones that are kept for more than 36 months before being sold. Real estate that is sold after 12 months is considered a long-term capital asset. The 12-month holding term, however, does apply to equity shares, securities, mutual fund units, etc. They would be referred to as long-term capital assets if they were sold off after a year. For an asset to be classified as a long-term capital asset under Section 54, it must be kept for longer than 24 months.

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

• The property that is to be sold should be a place of residence located in India.
• Only an individual or HUF is eligible for the benefit of Section 54.
• The transferred asset should be a residential property, which is a long-term capital asset. Income from sold property should be taxed under the head income from house property.
• The taxpayer must purchase a new residential property within a year of the old house's transfer date or build a new residential property within three years of the old house's transfer date, whichever comes first.
• When there is a forced acquisition, the time frame for construction or acquisition starts on the day that compensation (original or extra) is received.

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Exemptions Under Section 54

Section 54 of Income Tax Act offers tax exemptions from the capital gain tax to individuals and HUFs who are selling their residential property to purchase or construct a new residential property due to genuine causes like transfer, retirement, etc.

These exemptions are not available for taxpayers like partnership firms, companies, LLPs, associations, or other bodies. There are a few conditions that also need to be fulfilled if you wish to avail yourself of the benefits of these exemptions. These conditions are given below.

• The asset that is to be sold must be a long-term asset in terms of Section 54. This means that the owner should have owned the property for more than 24 months.
• In the event that the asset sold is the house of residence, the income from such a house should be charged as per the income generated from the house property.
• The owner of the sold property should necessarily purchase a new residential house within two years of the date of transfer or sale or one year before the date of transfer or sale.
• It is mandatory for both the sold and bought residences to be within India. It will not be possible to claim an exemption under Section 54 if you wish to buy a property outside India.

All of these conditions are compulsory, which means that even if one of the conditions is not fulfilled, you'll not be eligible to make use of Section 54.

Exemption Amount Available Under Section 54 of the Income Tax Act

Suppose you are moving somewhere, and you have a house that you’re selling to buy a new house at the new place. You sell your house for INR 50 lakh. You are making a new house at the place where you shifted, and it costs you INR 22 lakhs. So, the amount of money you saved, i.e., INR 28 lakhs, is the capital gain. And you’ll receive an exemption of INR 30 lakhs that you reinvested in another property.

This was a case where the total amount of exemption available under Section 54 was lowered in the case of long-term capital gains. There are two cases for this.

• If the capital gain arises on the transfer of a residence,
• If the investment is used in the construction or purchase of a new residential house.

Let us understand this with the help of a table with our example.

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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Conclusion

In conclusion, Section 54 of the Income Tax Act acts as a form of assistance for individuals who are selling their houses and are worried about the additional burden of taxes. It offers ways to reduce the amount of taxes that they must pay upon selling a home. In this sense, it eases the financial burden of purchasing a property and encourages individuals to do so.

Therefore, pay close attention to Section 54 if you're going to buy a new home and sell your current one, as it can help you save some money on taxes. Let SMFG Grihashakti be your trusted partner in your home ownership journey. With competitive interest rates, flexible loan terms, and quick disbursals, apply for a home loan with us today and turn your dream home into a reality!