What is Section 54 of Income Tax Act? And Conditions under Section 54 of Capital Gains

Introduction

Owners of residential properties are frequently forced to sell their homes for a variety of reasons, including relocation, career changes, retirement, and so on. If a seller of a residential property acquires or constructs another residential property from that amount, he or she is entitled to capital gains tax benefits under section 54 of the Income Tax Act. In other words, Section 54 under Income Tax Act, an assessee is free from capital gains when he or she sells a residential property and buys or builds another residential property. In today’s article information on “What is Section 54 of Income Tax Act?”, Conditions under section 54 of Capital Gains and long term capital gains on property is discussed. 

What is Section 54 of Income Tax Act?

If the profits from the sale of a property are used to purchase another residential property, the seller maybe eligible for capital gains tax relief under Section 54 of the Income Tax Act. When a person or HUF (Hindu Undivided Family) sells a home to buy another, it is considered that the reason for the sale was a change of residence, and he or she can file for Section 54 exemption. 

Conditions under Section 54 of Capital Gains

To obtain the benefit of section 54, the following conditions must be met.

• Only an individual or a HUF is eligible for the benefit of section 54.
• A long-term capital asset, such as a residential housing property, should be transferred.
• The taxpayer must purchase another residential house within one year before or two years after the date of transfer of the previous house, or construct a residential house within three years after the date of transfer of the old house. The time of acquisition or construction will be established in the case of compulsory acquisition from the date of receipt of compensation (whether original or additional).

The Finance Act of 2020 amended Section 54 with effect from Assessment Year 2021-22 to carry on the benefit of exemption in respect of investments made in two residential house properties. If the amount of long-term capital gains does not exceed INR 2 crores, an exemption will be provided for investments made by way of acquisition or building in two residential housing properties. If the assessee chooses this option, he will not be able to choose it again for the same or any subsequent assessment year. 

Different types of Capital Assets under Income Tax Act 

The assets are divided into two key sections for capital gains:

• Short term capital assets are capital assets that are held by an individual for less than 36 months. Short-term capital gains are the profits made from the selling of these assets.
• Long-term capital assets are capital assets that have been kept by the assessee for more than 36 months. Long-term capital gains are the profits made from the sale of these assets.

Unlisted stocks and land, as well as other immovable property, are considered long-term capital assets if held for more than 24 months. The assets listed below will be considered long-term capital assets.

• Units of an equity focused fund
• Any listed securities
• Bond with zero-coupon

To be considered a long-term capital asset under Section 54, the house property must be kept for more than 24 months.

Consequences if taxpayer transferred new house property within 3 years 

After selling an existing house property that is a long-term capital asset, the assessee might claim exemption under section 54 if he or she buys or builds a new house within the stipulated time limit.

Furthermore, if he or she wishes to sell the new property, he or she must keep it for a minimum of three years as required by section 54. If he or she sells before the deadline, the advantage will be revoked, and he or she will be required to pay the previously exempted capital gains tax.

If a new house property is sold within three years after its purchase/construction. Below is the scenario for calculating taxability on Long Term Capital Gain on Property:

• If the new house property’s cost is less than the capital gains estimated from the prior house property’s sale.
• In this situation, the capital gain that was exempt during the transfer of property is now taxable, and the cost of acquiring new assets is zero.

For long term capital gains on property Sections 54 and Section 54F are two of the most important exemptions available. Section 54, as previously indicated, exempts long term capital gains on property. Section 54F exempts long-term capital gains on the sale of any asset other than a residential property. Below is the table that explains the difference between Section 54 and Section 54F of the Income Tax Act.

Essential Points for Section 54 Under Income Tax Act

• If the new residential property’s cost is less than the total transaction price, the exemption is granted proportionately. Within six months, you can reinvest the leftover funds under Section 54EC.
• The property must only be purchased in the seller’s name and not in the name of anyone else.
• The exemption is still available if the builder of a new residential development fails to hand over the property to the taxpayer within three years after purchase.

Conclusion

The benefits of the exemption on the sale of residential property are explained in Section 54 under Income Tax Act. Under this clause, long-term capital gains on the sale of a residential property are eligible for tax incentives. This benefit can be claimed by either purchasing/constructing a new residential property or placing the sale profits in any authorised/approved bank’s Capital Gains Account Scheme.