Section 54 of the Income Tax Act – Capital Gains Exemption on Sale of Residential Property

Section 54 of the Income Tax Act allows taxpayers to claim exemption from long-term capital gains tax if the gains are reinvested into another residential property. A new house can be purchased within 2 years or constructed within 3 years from the date of sale. The maximum exemption available under this section is up to ₹10 crore. This provision enables taxpayers to reduce their tax liability by reinvesting the proceeds from the sale into a new residential home, provided the conditions of the Act are met.

Key Highlights

• Exemption applies only to long-term capital gains on the sale of a residential house.
• The maximum exemption available is ₹10 crore.
• If the capital gain does not exceed ₹2 crore, exemption can be claimed on the purchase of two residential houses. Otherwise, it is limited to one house.

 

What is Section 54?

Section 54 provides relief from long-term capital gains tax when an individual sells a residential house and reinvests the capital gains into another residential property. The exemption is limited to ₹10 crore and applies only to long-term capital gains arising from house property.

Who Can Claim Exemption under Section 54?

• Eligible: Individuals and Hindu Undivided Families (HUFs).
• Not Eligible: Firms, LLPs, companies, and other entities.

Key Conditions for Claiming Section 54 Exemption

• The property sold must be a long-term capital asset (held for more than 24 months).
• The asset must be a residential house property, with income taxable under “Income from House Property.”
• Exemption is capped at ₹10 crore.
• If capital gains are up to ₹2 crore, exemption can be claimed on two houses (purchase or construction). This benefit is available only once in a lifetime.
• The new residential property must be located in India. Purchase of property abroad does not qualify.
• The taxpayer must:
  
  • Purchase another house within 1 year before or 2 years after the sale, OR
  • Construct a house within 3 years from the date of sale or compensation (in case of compulsory acquisition).

 

Timeline for Acquisition of New Property

Acquisition Type	Purchase Deadline	Construction Deadline
Before sale of property	Within 1 year	Within 1 year
After sale of property	Within 2 years	Within 3 years

Failure to satisfy even one of the prescribed conditions will make the seller ineligible to claim exemption under Section 54.

Amount of Exemption Available under Section 54 of the Income Tax Act

The exemption under Section 54 for long-term capital gains will be the lower of:

1. The amount of long-term capital gains arising from the sale of the residential house, OR
2. The amount invested in the purchase or construction of a new residential house property.

Any remaining capital gains (if applicable) will be taxable.

Example:

Mr. Sachin sells his villa (residential house) for ₹45 lakhs. Out of this, he invests ₹20 lakhs in purchasing another villa. The calculation is as follows:

Particulars	Amount (₹)
Capital gain on sale of house	45,00,000
Less: Investment in new residential property	20,00,000
Taxable Capital Gains	25,00,000

Here, the exemption will be the lower of capital gains (₹45 lakhs) or investment (₹20 lakhs). Therefore, the exemption allowed is ₹20 lakhs.

 

 

Limit for Capital Gains Exemption on Sale of Residential House

As per Budget 2023, the maximum long-term capital gains exemption available under Section 54 has been capped at ₹10 crores, applicable in the following cases:

Section	Sale of	Investment Allowed In	Maximum Exemption
Section 54	Residential property	New residential property	₹10 crores
Section 54F	Any long-term asset (other than residential property)	New residential property	₹10 crores*

*Subject to prescribed calculation rules.

Sale of New Property Within 3 Years

If the newly purchased or constructed property is sold within 3 years of its acquisition, the exemption claimed earlier under Section 54 becomes taxable in the year of sale.

The cost of acquisition of the new property will be adjusted as follows:

Particulars	Amount (₹)
Original Cost of New Property	XXX
Less: Exemption claimed earlier	XXX
Adjusted Cost of New Property	XXX

Example:

• Mr. Ganguly sells a residential house in June 2015, earning capital gains of ₹25 lakhs.
• In October 2015, he purchases another property for ₹40 lakhs.
• In January 2017, he sells the new house for ₹55 lakhs.

Computation:

FY 2015-16 (Sale in June 2015):

Particulars	Amount (₹)
Capital gain on original property	25,00,000
Less: Investment in new property	40,00,000
Taxable Capital Gain	NIL

FY 2016-17 (Sale in January 2017):

Particulars	Amount (₹)
Sale consideration of new house	55,00,000
Less: Adjusted Cost (₹40 lakhs – ₹25 lakhs exemption claimed)	15,00,000
Taxable Capital Gains	40,00,000

Thus, the earlier exemption is withdrawn and taxed upon the sale of the new property within 3 years.

What is the Capital Gains Account Scheme (CGAS)?

The Capital Gains Account Scheme (CGAS) is designed to help taxpayers claim exemption on capital gains when they have not yet purchased or constructed a new residential property within the required time frame.

If the new house is not purchased within 2 years or constructed within 3 years, the unutilized capital gains must be deposited in a CGAS account with a public sector bank before the due date of filing the income tax return.

Both the amount already spent on buying or constructing a new property and the amount deposited in the CGAS will be considered for exemption. However, if the deposited amount remains unused after the prescribed period, it will be treated as taxable income in the year the 3-year deadline from the original sale expires.

Section 54 vs Section 54F

Taxpayers often confuse Section 54 with Section 54F. While both sections provide capital gains exemptions under similar conditions and limits, they apply to different categories of assets.

Common Conditions under Section 54 & Section 54F:

• A new residential house must be purchased or constructed.
• The purchase should be made within 1 year before or 2 years after the sale of the original asset.
• Alternatively, construction should be completed within 3 years from the sale.
• If reinvestment is not made within the due date for filing the income tax return or within 1 year from the sale, the amount must be deposited in a Capital Gains Account Scheme (CGAS) in a public sector bank.

Differences Between Section 54 and Section 54F

Section 54	Section 54F
To claim full exemption, the entire capital gains must be invested.	To claim full exemption, the entire sale proceeds must be invested.
If the full capital gains are not invested, the uninvested amount is taxed as long-term capital gains.	If the full sale proceeds are not invested, exemption is granted proportionately: Exemption = Cost of new house × Capital Gains ÷ Sale Proceeds.
You must not own more than one residential house at the time of sale of the original asset.	The exemption will be reversed if the new property is sold within 3 years of purchase, or if another residential house is purchased within 2 years or constructed within 3 years of the original sale. Capital gains from the sale of the new property will be taxed as long-term capital gains.
Exemption is reversed if the new property is sold within 3 years of acquisition, and gains are taxed as short-term capital gains.	Not applicable.
If capital gains do not exceed ₹2 crores, a once-in-a-lifetime exemption is available for investment in two residential properties.	No such provision exists.

Key Points to Remember

• Proportionate Exemption: If the cost of the new residential property is less than the total capital gains, exemption is allowed only for the invested amount. The remaining gains can be reinvested under Section 54EC within 6 months to claim additional exemption.
• Ownership: The new property must be purchased in the name of the seller to claim exemption.
• Builder Delay: If the builder fails to deliver the property within 3 years, the exemption remains valid, provided the investment was made according to the prescribed conditions.

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