Capital gains exemption under Section 54 of Income Tax Act

Real estate investment has always been a favored strategy for many individuals seeking substantial returns while managing risk.

However, these significant profits often have considerable tax liabilities. Capital gains tax is applicable to both short-term and long-term profits from sale of property.

To reduce this tax burden, the Income Tax Act offers a range of deductions and exemptions including sec 54 exemption.

Sec 54 exemption provides a valuable tax advantage to homeowners. If you sell your primary residence and use the proceeds to purchase or construct another residential property within a specified timeframe, you may be eligible to significantly reduce or even eliminate the capital gains tax on the sale of your original property via sec 54 exemption.

Section 54 of the Income Tax Act, 1961:

Section 54 of the Income Tax Act of 1961 offers a significant tax advantage to homeowners in India allowing them to reduce or eliminate the capital gains tax they owe on the sale of their primary residence.

To qualify for sec 54 exemption, the proceeds from the sale of the original property must be reinvested in the purchase or construction of another residential property within a specific time period.

It's crucial to note that sec 54 exemption only applies to long-term capital gains, which means the original property must have been owned for more than 24 months before its sale.

Different Types of Capital Assets Under Income Tax:

• Capital gains arise when an asset is sold for a profit. The tax treatment of these gains depends on the holding period of the asset, categorizing them as either short-term or long-term.
• Short-Term Capital Assets: Assets held for less than 36 months are considered short-term. Gains from selling these assets are taxed at the individual's applicable income tax slab.
• Long-Term Capital Assets: Assets held for more than 36 months are classified as long-term. Gains from these assets are generally taxed at a lower rate than short-term gains.
• Specific Holding Periods for Long-Term Capital Assets:

a) Unlisted Shares, Land, Immovable Property: These assets are considered long-term if held for over 24 months.

b) Listed Securities, Equity-Oriented Funds, Zero-Coupon Bonds: These assets are considered long-term if held for over 12 months.

Sec 54 exemption and Long-Term Capital Gains on Residential Property:

• Section 54 of the Income Tax Act specifically addresses long-term capital gains from the sale of a residential property on which you can get sec 54 exemption.
• To qualify for sec 54 exemption, the property must have been held for more than 24 months before its sale.
• The holding period for an asset significantly impacts its tax treatment.
• Understanding these distinctions is crucial for individuals who invest in assets that may generate capital gains.
• Sec 54 exemption provides a valuable tax advantage for homeowners who reinvest the proceeds from the sale of their primary residence in another residential property.

Eligibility criteria for sec 54 exemption:

• Section 54 of the Income Tax Act provides an exemption i.e. sec 54 exemption from capital gains tax on the sale of a residential property under specific conditions.
• Only individuals and Hindu Undivided Families (HUFs) are eligible for sec 54 exemption. Companies are not covered under this.
• The property being sold must be a long-term capital asset, meaning it was owned for more than 24 months to be eligible for sec 54 exemption.
• The property sold must be a residential house, generating income taxable under the "Income from House Property" head to get sec 54 exemption.
• As per sec 54 exemption eligibility criteria, the new residential property must be purchased within one year before the sale or within two years after the sale. For property construction, the timeframe is extended to three years after the sale.
• The new property must be located within India to get sec 54 exemption.
• Failure to meet any of these conditions will disqualify the taxpayer from claiming the sec 54 exemption.

Key Conditions for Claiming sec 54 Exemption:

• To successfully claim the sec 54 exemption on capital gains from the sale of a residential property, all of the following conditions must be met:
• The sold property must be a long-term capital asset (held for over 24 months) and categorized as a residential house under the "Income from House Property" head.
• A new residential property must be purchased within a specific timeframe:

1. Within one year before the sale
2. Within two years after the sale
3. Within three years after the sale for property construction

Timelines may vary in cases of compulsory acquisition.

• As per sec 54 exemption eligibility criteria the new residential property must be situated within India.
• The sec 54 exemption amount is now capped at ₹10 crore from April 1, 2023.
• All of these conditions must be met simultaneously. Failure to fulfill any one of them will render the taxpayer ineligible for the sec 54 exemption.

Sec 54 Exemption: Calculation and Limitations:

• Section 54 of income tax act allows taxpayers to claim sec 54 exemption from capital gains tax on the sale of a residential property. The sec 54 exemption amount is determined by the lower of:

1. The actual capital gains realized from the sale of the property.
2. The cost of purchasing or constructing the new residential property.

• Effective from Assessment Year 2024-25, the Finance Act 2023 introduced a cap on the sec 54 exemption amount. If the cost of the new property exceeds ₹10 crore, the excess amount will not be considered for calculating the sec 54 exemption.
• Example: If Mr. Aman sells his house for a capital gain of ₹40,00,000 and uses the proceeds to buy a new house for ₹25,00,000, his sec 54 exemption will be ₹25,00,000 (the lower of the two amounts). Consequently, he will be liable to pay capital gains tax on the remaining ₹15,00,000 (₹40,00,000 - ₹25,00,000).