Income Tax Section 54 – Tool to save Long Term Capital Gains

As we had discussed in our previous article, whenever a “Capital Asset” is transferred by a person, Long Term or Short term Capital Gain Tax is attracted depending upon the period of holding of the asset. Such gains can form a significant portion of one’s Total Income resulting in significant tax outflow.

However, the Income Tax Act 1961, provides us with certain exemptions under Section 54, 54B, 54D, 54EC, 54F, 54G and 54GA which can be used by an assessee to claim exemptions and reduce his/her tax liability.   

In this article we would focus on the main provisions of Section 54 and understand how we can take advantage of this section to reduce the tax liability arising from Capital gains.

Applicability of Section 54

The Income Tax Act has restricted the applicability of this section only to Individuals or Hindu Undivided Family (HUF)

In other words, the advantage of this section cannot be taken by Companies, Partnership Firm, Association of Persons (AOP), Cooperative Societies, Trusts and Body of Individuals (BOI).

Moreover, the assessee must satisfy certain primary conditions for availing the benefit of this section.

These conditions are:

1)The Capital Asset which has been transferred by the assessee must have been a residential house.

In other words, if you have sold an office or a commercial shop, then exemption under this section cannot be claimed.

2)The income from such residential house must have been charged under the head “Income from House Property.”

Therefore if you were earning any rent from the residential house prior to selling it, the same must have been shown under “Income from House Property” only.

 3)The residential house property must have been a “LONG TERM CAPITAL ASSET”. This implies that the house must have been owned by you for a minimum period of 36 months immediately preceding the date of transfer.

 4)The assessee must either purchase or construct another residential house within the stipulated time period.

 In case of purchase, the same should be made within a period of 1 year before or 2 years after the date of transfer.In case of construction the same must be completed within 3 years from the date of transfer. When the construction begins is not relevant.

5)Amount of Exemption

The amount which is available for exemption is the lower of the following two amounts (A) and (B):

-          The amount of Long Term Capital Gain arising on transfer of existing residential house property (A)

-          The amount invested in the purchase or construction of new residential house property (B)

 6)Capital Gains Scheme

A very valid question that arises at this point is that the amount which is spent over purchase or construction may be spread over the period of 2 or 3 years respectively as per the time allowed for investment in this section in point number 4. However the due date for filing the return of Income under Section 139(1) is 31st July( and 30th September, as the case may be) of the Assessment Year itself.So there is quite a possibility that the assessee would not have invested the entire amount for purchase or construction of the house by the due to of filing his/her return.

Hence, the section stipulates that where the full amount cannot be invested by the assessee by the due date of filing the return of income, the assessee can deposit the unutilised amount under the Capital gains Scheme on or before the due date of filing the return of income.

The asset can be later purchase or constructed within the stipulated time by withdrawing the money from the aforesaid scheme.

This can be understood with the help of an example:

Suppose, Mr David sells his residential house property on 1st July 2011 which falls in the Financial Year 2011- 2012. In this particular case, as per section 139(1), Mr David is required to file his Income Tax Return by 31st July 2012.

However, the time allowed to him under section 54 for purchase or construction for new house is as follows:

For Purchase of Residential House- Either within 1 year prior to the date of transfer i.e. after 1st July 2010 or within 2 years after the date of transfer i.e. before  1st July 2013.   

In case of construction- The construction must be completed within 3 years from the date of transfer i.e. before 1st July 2014.

Let us assume that Mr David plans on purchasing a new house in January 2013 which is well within the above time limit allowed for purchase but after the time limit for filing the return of Income (which is 31st July 2012). Therefore in this case he would have to make a deposit of the anticipated amount of purchase cost into the capital gains account on or before 31st July 2012 which he can later withdraw to make the purchase of the house in January 2013.

7)The amount deposited in the Capital Gains Scheme must be utilized within the time stipulated in supra mentioned point 4.

In other words, the amount deposited in the capital gains scheme must be utilised for construction of new residential house within a maximum period of 3 years for the date of transfer of original house property or in the case of purchase the said amount must be utilised within a period of 2 years from the date of transfer of original house property. If this does not happen then the unutilized amount shall be treated as LONG TERM CAPITAL GAIN in such year in which the time period of 3 years has expired.

 8)The newly purchased or constructed residential house shall not be transferred within 3 years from its purchase or completion of construction.

If the new residential house property is transferred within 3 years of its purchase or construction, the while calculating the SHORT TERM CAPITAL GAINS on transfer of this new house property, its cost of acquisition will be reduced by the amount of exemption claimed earlier under Section 54.

FOR GREATER CLARITY LET US UNDERSTAND WITH THE HELP OF A COMPREHENSIVE EXAMPLE.

Suppose Mr. Shiriish has a residential house in Mumbai which he has acquired on 1st September 1999 for Rs 5 Lacs. He sells the same on 1st July 2011 for Rs 50 Lacs.

Also, he decided to purchase another residential flat in Delhi in January 2013 for around Rs 35 Lacs. Accordingly he deposits the entire amount of Rs 35 Lacs in the capital gains account scheme.

Hence his Long Term Capital Gains Tax shall be calculated as follows: 

Hence, by utilizing the benefit of Section 54  Mr. Shiriish will pay LTCG tax @ 20% on Rs 4,41,003 which will amount to Rs 88,201 only.

Now, suppose, in January 2013, the house actually purchased by Mr Shiriish costs only Rs 32 Lacs against the estimate or Rs 35 Lacs. Also, the balance of Rs 3 Lacs remains unutilized till the expiry of 3 years from the date of transfer (i.e. 1st July 2014).

In this case the unutilized amount of Rs 3 Lacs shall be treated as LONG TERM CAPITAL GAINS for the Financial Year 2014-2015 and will be taxed at the rate prevailing at that time.   

Happy Savings!!

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About CA Shiriish Bubna
I have a fetish for money and everything associated with wealth creation. Having completed MBA (Finance) from IMT, Ghaziabad in 2008 where I was a silver medallist; I worked with General Electric for a period of 2 years in their revered FMP program. FMP is GE's Leadership program for grooming future leaders in the field of finance. The program is spread over 4 six monthly rotations which gives its members exposure to different GE business. During my tenure as a program member I worked in areas such as Accounting, Auditing, Financial Planning and Budgeting. I quit GE to join my family business in 2010. I am currently responsible for Team Building, Enhancing and Increasing penetration of the company brand image and driving new growth initiatives. During this time, I also completed Chartered Accountancy in 2011. Though a non practising CA, I manage my own equity portfolio and keep myself updated on the stocks, mutual funds and tax related issues.

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