Did you know that you can avoid paying taxes on sale of residential property? The Income Tax Act provides certain specific tax exemptions in case residential property is sold and the assessee reinvests the amount of capital gains in the purchase of another residential property.
Such exemption is available under Section 54 of the Income Tax Act for the following:
The asset sold is residential house property
The asset sold is long term capital asset
The asset purchased should be residential house property
The purchase should be made within a period of one year before or two years after the date of transfer of old house property, the taxpayer should acquire or build a property within a period of three years from the date of transfer of the old house
The property purchased/constructed should be India
The exemption under Section 54 can be claimed only for one residential house property purchased/constructed. However, Section 54 has been amended, w.e.f 1 April 2020 and the benefit of exemption is available in respect of investment made in two residential house properties if the amount of long-term capital gains does not exceed Rs. 2 crore. This option can be exercised only once by an assessee during his/her lifetime.
For example, Nitin owned residential house A for 10 years. He bought a new residential house B on 1 February 2020 worth Rs. 1 crore. Nitin sold house A on 2 January 2021 for Rs. 10 crore. The capital gains arising on this sale was Rs. 2 crore. On 1 March 2022 Mr. Nitin purchased house C worth Rs. 1 crore. He believes that exemption can be claimed in respect of capital gains arising on transfer house A since houses B and C have been purchased within the time frame of one year before or two years after. Also, the capital gain is less than Rs. 2 crore and hence he will be able to exercise the once-in-a-lifetime option of claiming deduction by investing capital gains in two houses. In this case, his understanding is correct. It is pertinent to note that CG shall be exempt to the extent of CG or amount invested in the purchase/ construction of another house, whichever is less.
It is interesting to know what happens if the new residential house property purchased or constructed for claiming deduction under Section 54 is transferred within a period of three years from the date of acquisition. The exemption claimed will be withdrawn. The amount claimed as exempt earlier will be deducted from the cost of acquisition of the new house property.
Suppose, Siddharth held 2 house properties L, M for the past 8 years. He sold house L for Rs. 1.75 crore in September 2020 and made a CG of Rs. 70 lakh. He purchased another house property N in December 2020 for Rs. 1 crore. He files the ITR in July 2021 and claimed exemption for the entire capital i.e. Rs. 70 lakhs.
Now, in August 2021, he sold house N for Rs. 1.05 crore. Thus, capital gain will be Rs. 5 lakhs. He does not have any other income during the year. He believes that he will not be liable to pay any tax due to rebate u/s 87A. This belief of Siddharth is not correct; he sold the house property before completion of 3 years and had claimed Section 54 exemption to the tune of Rs. 70 lakh. Hence, for the purpose of computation of short-term capital gains, the earlier exemption of Rs. 70 lakh will be deducted from the cost of acquisition of Rs. 1 crore. The cost of acquisition for income tax purpose will be Rs. 30 lakh (Rs. 1 crore less Rs. 70 lakh). The short-term capital gains will be Rs. 75 lakh (sale value of Rs. 1.05 crore less new computed cost of acquisition Rs. 30 lakh).
Suppose Mr. Rahul sold house property A in July for Rs. 10 crore and earned long-term capital gains of Rs. 4 crore. House B is purchased for Rs. 5 crore in August 2021 in his spouse’s name. Can he claim exemption under Section 54?
In a recent ruling, Bhagwan Swroop Pathak vs ITO, the Delhi bench of the Income Tax Appellate Tribunal (ITAT) and CIT(A) vs Kamal Vahal 351 ITR 4, the Delhi High Court has held that individual shall be eligible for CG exemption if he invests the entire LTCG towards the investment in another property in the name of the spouse or other relative.
Nitesh Buddhadev, CA, is founder of Nimit Consultancy