When Can We claim Exemption Under Section 54F Of Income Tax Act and When You Cant

income tax

Capital asset

A capital asset is a property that is expected to generate value over a long period, and it has an expected useful life of more than one year. Example: building, plant, machinery, gold.

Long-term capital gain under section 54F

The benefit of capital gains deduction is given on capital gains arising from any long-term capital assets other than a residential house property.

Case 1: When the entire amount is re-invested

In the case when the entire amount from the sale of assets is re-invested for the purchase/construction of the residential house, the investors can claim exemption on the entire capital gains.

Case 2: When a part of sale proceeds is invested

In case when a part of the sale proceeds is re-invested, the capital gains exemption under section 54F is calculated on the proportion of the amount re-invested. For instance, if the investor has a net consideration of 60 lakhs and the indexation cost of acquisition is 10 lakhs, re-invests Rs 40 lakh. Capital gains exempted are calculated as

Sol: (LTCG*Amount invested)/net sale consideration= capital gain exempted

(50 lakh*40 lakh)/ 60 lakhs = Rs. 33.33 lakhs

What is the condition to claim the deduction?

  • The assessee must own only one residential house on the original asset's transfer date.
  • The assessee shall not purchase any residential house, other than a new asset, within one year after the original asset's sale date.
  • The assessee shall not construct any residential house, other than the new asset within 3 years from the original asset's transfer date.

The deduction cannot be claimed if these conditions are not met.

Example 1: Mr Rohan’s father owns a property in Mysore; Mr Rohan and his father sold equity worth ₹.50,00,000 each to purchase a new property only in the name of Mr Rohan. The impact of section 54F will be as follows:

Mr Rohan, as of the date of sale, is not the owner of more than one residential property. Mr Rohan’s father, as of the date of sale, is the owner of only one residential property. Both Mr Rohan and his father can claim a deduction under section 54F. By availing the services of a tax consulting expert, Mr Rohan and his father can ensure that they minimise their tax liability and maximise their tax savings while complying with all applicable tax laws and regulations

Example 2:Ms Pragati and her mom made a payment of ₹.40,00,000 as part of payment towards under construction property. The builder has put forth a second instalment due date reminder for which both the buyers of the new property intend to sell further equity to the tune of ₹.50,00,000/-. Explain the impact of section 54F.

Section 54F states the assessee can claim a deduction on the sale of the original asset, which is other than a residential property. The section states a new property must be purchased within 2 years from the date of transfer of the original asset, or a new property be constructed within 3 years from the date of transfer of the original asset. If the assessee could not apportion the capital gains before one year from the transfer of the original asset or purchase or construct within the due date of filing the return of income, such original asset capital gains be deposited in Capital Gains Account Scheme. The section does not state that new asset investments cannot be made in instalments.

In ACIT New Delhi v Mahinder Kumar Jain IT Appeal, it was noted that the Capital Gains on the sale of house property could be invested in the construction of house property more than once for the same new property if the cost of property is within the capital gains that arose to the assessee.

Example 3:Mr Anirudh availed a loan of ₹.85,00,000/- from a nationalised bank. He has plans to sell one existing old residential property. Will the proceeds from the sale of residential property fetch any tax benefits for Mr Anirudh under section 54 or 54F or any other relevant section under the Income Tax Act, 1961, who has earlier reinvested equity into a new property.

Analysis:Equity is sold, and its proceeds are invested in buying a new property – Section 54F allows deduction as the asset sold is other than residential property. The old property and capital gains proceeds can be deducted under section 54.

Example:If the assessee constructs or purchases a residential house out of the borrowed funds, he is not eligible for deduction u/s 54F of the Act.

Milan Sharad Ruparel vs Assistant Commissioner of Income Tax. ITAT (Income Tax Appellate Tribunal)

  • In this case, the assessee claimed exemption under section 54F against the long-term capital gain of Rs. 14, 18,890 earned on sales of shares for aggregate consideration of Rs. 17,28,686.
  • This exemption under Section 54F was claimed on account of purchase of residential flat through an agreement dated 15th June 2004 for the total cost of Rs. 17, 29,355.
  • The assessee received possession of the said residential flat on 1st July 2004.
  • The assessee had applied for a loan of Rs. 15 lakhs dated 29th June 2004, and the bank sanctioned the loan on that date, and the housing loan amount was utilised to purchase a residential flat.
  • The assessee claimed exemption under Section 54F in respect of the above referred long-term gain of Rs. 14, 18,890 treating the cost of the residential flat of Rs. 17,29,339, which was more than the sale proceeds of the said share and hence capital gain was shown at nil.
  • The AO disallowed the assessee's claim and allowed the exemption under Section 54F on a proportionate basis considering only the balance cost of Rs. 2,28,000 eligible for exemption under Section 54F and computed the exemption only at Rs. 1,87,264.

Circumstances under which Section 54F exemption would be withdrawn. The assessee cannot transfer the newly purchased or constructed residential house for three years from the date of purchase or the date of construction. However, if the assessee transfers the newly purchased/ constructed residential house, the capital gain exempted under section 54F would be taxable as a long-term capital gain in the previous year in which the residential house was transferred.

Are NRIs allowed to claim an exemption under section 54F?

NRIs must know the international taxation rules for claiming exemptions under Section 54F on long-term capital gains. Therefore, an NRI can take benefit of the exemptions from capital gains when filing a return and claim a refund of TDS deducted from Capital Gains.

Applicability of section 54F on property received as a gift

An immovable property received as a gift, when sold, will be subject to income tax on the capital gain earned on the sale. To determine the capital gains, the acquisition cost will be the cost to the last owner who purchased it. Also, the holding period will be from when the owner first held it.

Example: A property was purchased by Anil on April 1, 1998, for Rs. 4 lakhs and was gifted to his son, Ranjith, on October 1, 2007. Ranjith subsequently gifted the property to their son, Karan, on April 1, 2013. Karan sold the gifted property on April 1, 2014, for Rs. 55 lakhs.

The holding period of such property for Karan would be 16 years, i.e., from the date of purchase by Anil on April 1, 1998, to April 1, 2014, and the cost of acquisition will be Rs. 3 lakhs, i.e., the cost to Anil. The cost can be indexed for inflation since the holding period is over 3 years.

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