Section 54 of Income Tax Act: Capital Gains Exemption Series

Selling a home can be an emotional and significant financial decision. While the excitement of moving on to a new chapter is undeniable, the thought of paying capital gains tax can add stress to the process. Thankfully, Section 54 of the Income Tax Act offers relief by allowing individuals and Hindu Undivided Families (HUFs) to claim an exemption on the capital gains from the sale of a residential property, provided those gains are reinvested in another residential property.

In this blog, part of our Capital Gains Exemption Series, we’ll take you through the ins and outs of Section 54 explaining who can benefit, what conditions need to be met, and how this exemption can ease your tax burden.

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Table of content

Capital Gains Taxation: A Brief Introduction

Are All Capital Gains Taxable?

Various exemptions from Capital Gains of Section 54 Series

Capital Gain Account Scheme

Budget 2023 and Section 54 

Amount of Exemption Under Section 54:

Comparison Between Various Sections of Exemption from Capital Gains

FAQ

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Are All Capital Gains Taxable?

Not all capital gains are taxable. The income tax law has provisions for exempting some capital gains, and no tax is payable by the taxpayers. These exemptions are granted for relieving the income from sale of capital assets, subject to certain conditions, from taxation. 

The major categories under these exemptions are:

• Residential Property: Such capital gains realized by sale of residential property shall be exempt if sale proceeds are reinvested in another residential property.

• Agricultural Land: Gain on sale of agriculture land in a rural area is exempt from capital gains tax.

• Investments in Bonds: Gains can be exempt if reinvested in specified bonds under Section 54EC of the Income Tax Act.

• Small Business Stock: Certain gains from the sale of small business stock are exempt if certain conditions are met.

Benefits of Being Classified as a Long-Term Capital Asset

For taxpayers, the designation of an asset as a long-term capital asset has several advantages, such as

Reduced Tax Rates: In general, long-term capital gains (LTCG) are taxed at a lower rate than short-term capital gains. The LTCG tax rate is 10% without indexation and 20% with indexation. This is usually better than the individual's relevant income tax rate, which is the short-term capital gains tax rate.

The benefit of Indexation: Taxpayers may gain from indexation, which modifies the asset's purchase price for inflation if the asset is kept for a longer length of time. Taking into account the rise in living expenses during the holding period, this aids in lowering the capital gains tax obligation.

Exemptions under Section 54: The Income Tax Act has a number of provisions (including provisions 54, 54F, and 54EC) that provide deductions or exemptions for long-term capital gains if the proceeds of the sale are reinvested in certain assets, such as bonds or residential real estate. This promotes long-term investments by incentivizing taxpayers to reinvest their earnings.

Capital Gains Account Scheme (CGAS): The sale profits may be put into a bank's Capital Gains Account Scheme (CGAS) if the taxpayer cannot reinvest the funds right away. In this case, the amount deposited is considered a specified investment for exemption purposes. If more money has to be invested, it may be taken out as required.

Beneficial Treatment for Specific Assets: Certain assets, such as equities shares and equity-oriented mutual funds, get restorative tax treatment for long-term profits. As of my previous update, long-term gains on equities shares and stock-oriented mutual funds were tax-free up to a specific amount.

Encouragement of Long-Term Investment: The government incentivizes investors to adopt a long-term investment perspective by taxing long-term returns at a reduced rate. Long-term investments promote stability and development, which may be advantageous for investors as well as the economy.

Various exemptions from Capital Gains of Section 54 Series

Section 54

Subject to certain restrictions, capital gains from the sale of a residential property utilized for residential purposes are excluded under Section 54 of the Income Tax Act. In order to be eligible for this exemption,

• Either a person or a Hindu Undivided Family (H.U.F.) must be the assessee.

• It was appropriate to hold the residential property for longer than three months.

• The acquisition of a new property must occur either 12 months before or 24 months after the sale of the previous property.

• As an alternative, a new home may be built within 36 months of selling the previous property.

• The money from the sale should be less than the new property costs.

• In the year of the old property's sale, if the capital gains are less than the cost of the new property, the difference is considered long-term capital gains and is subject to a 20% tax rate.

The cost of the new property is subtracted from the amount of previously exempt capital gains if it is sold within 36 months of its construction or acquisition. For the year of the new property's sale, the minor difference between the cost and the selling price is recognized as a short-term capital gain.

Section 54B

Gains from the sale of agricultural land in rural regions are not taxed under Capital Gains since such land is not considered a capital asset. Regular transactions involving agricultural property or land used for commercial purposes fall within the retail and profession category, thus free from capital gains tax.  In order to be eligible for this exemption:

• In non-rural regions, if the property was utilized for agricultural purposes for two years prior to the transfer, individuals or Hindu Undivided Families (HUFs) may be eligible for capital gains exemption under Section 54B.

• The seller must buy another piece of agricultural property within two years and not sell it for three years in order to be eligible for the Section 54B exemption.

• Under the Capital Gains Account Scheme, deposited capital gains may be claimed for exemption if the buyer is unable to close the deal before submitting the tax return.

• Amounts placed that are not used for the purchase of land within the allotted time frame are taxed in the year that the two-year term ends, although they may still be withdrawn for other uses.

Section 54D

Exemption from capital gain under Section 54D for compulsory purchases of land or structures constituting an industrial undertaking. The following requirements must be met by the taxpayer in order for them to be eligible for exemption under Section 54D of the Income Tax Act:

• Individuals of any category are eligible for the exemption under Section 54D in the event that land or buildings necessary for an industrial project are acquired via force.

• Under Section 54D, both long-term capital assets and short-term capital assets are included.

• Prior to the purchase date, the transferred asset had to be used for industrial purposes for at least two years.

• The compensation sum must be reinvested by the transferor in another piece of property or structure in order to relocate or reestablish industrial units. This investment has to be made within three years of the compensation date.

If these requirements are satisfied, the assessee may use Section 54D's exemption advantages.

Section 54EC

When reinvested in approved long-term assets, proceeds from the sale of a long-term capital asset may be excluded from taxes. If people decide to reinvest their capital gains in certain assets, such as those provided by the Rural Electrification Corporation or NHAI, they are qualified for these exemptions. To qualify for this exemption from capital gains, one must meet the following criteria:

• Within six months of the original asset's sale, individuals are required to reinvest the profits in designated assets.

• Reinvesting capital profits should stay within the original investment sum. The exemption only covers the amount reinvested if just a part of the profits are reinvested.

• For the capital gain exemption to apply, the designated assets purchased via reinvestment must be held for a minimum of 36 months.

Individuals may take advantage of the long-term capital gain exemption by meeting specific requirements, which promotes thoughtful reinvestment in designated assets.

Section 54EE

Under some circumstances, profits from the transfer of long-term capital assets may be free from capital gains tax.

• The individuals must reinvest the transfer funds within six months after the transaction.

• The previously granted exemption will be subtracted from the cost of the newly purchased assets to compute capital gains if they are sold within 36 months.

• Before the 36-month mark, a loan backed by the new assets will be considered a capital gain.

• To be eligible for the exemption, the total amount invested in the current and the next financial year must be more than Rs. 50 Lakh.

Following these guidelines allows people to take advantage of capital gain exemptions, which encourage prudent money management and thoughtful reinvestment.

Section 54F

If capital gains are reinvested in residential real estate, proceeds from the sale of capital assets—apart from residential dwelling properties—may be excluded from capital gains taxes. These exclusions may only be claimed under the following circumstances:

• The exemption is available to the assessee, who may be a person or a Hindu Undivided Family (H.U.F).

• The new residential property must be built or acquired within 36 months of the capital asset sale date, or it needs to be bought 12 months before or 24 months after the asset sale.

• The asset's selling price should be the price of the brand-new house.

• If people don't want to reinvest after a certain amount of time, they may register an account under the Capital Gains Scheme and utilize the money for building or buying a home.

• A person should own up to one residential property on the asset's selling date. They also should wait to buy another residential property or start building on one within 24 to 36 months of the original date.

Understanding these requirements is essential for those looking to reduce their tax obligations and take advantage of capital gains exemptions—which open up opportunities for wise investment and prevent double taxation. Keep yourself updated on the exemptions that will be in effect in 2022 to maximize financial returns and tax planning.

Section 54G

The transfer of assets, including land and buildings, equipment and machinery, and any right in land and buildings used for an industrial venture in an urban area, is excluded from this rule. The resultant capital gain may be used toward the acquisition or development of real estate, buildings, equipment, and plant and toward costs associated with moving the previous industrial project. Expenditures defined by the government also qualify. “Each and every kind of assessee is eligible for this exemption.”

Conditions to avail of this exemption are:

• There are two types of transferred capital assets either short-term or long-term.

• Acquisitions of land, buildings, or equipment must be made within a year before to or three years after the transfer date.

• The transfer needs to happen as a result of the industrial enterprise moving from an urban region to any other location—that is, outside of urban areas.

• The exemption amount is determined by subtracting the capital gain amount from the land, buildings, or equipment investment.

This clause promotes the growth and adaptability of businesses by providing a thorough framework for capital gains exemptions in industrial relocation instances.

Section 54GA

Capital gains on the transfer of capital assets (land, equipment, plant, and buildings) of an industrial business situated in an urban area are excluded under section 54GA of the Income Tax Act. The industrial venture must relocate to a Special Economic Zone (SEZ) in order to qualify for this exemption. Prerequisites for the Exemption are:

• Section 54GA allows all types of people to seek exemption.

• Under Section 54GA, capital gains, both long-term and short-term, are excluded.

• An exemption is available for the transfer of any equipment, land, or building rights as long as the industrial activity is located in an urban area and the property is used for commercial purposes.

• The amount of the capital gain may be used to finance the industrial undertaking's relocation to a Special Economic Zone for a number of reasons, such as buying equipment or machinery, obtaining land, building a new facility or buying an existing one, and incurring additional costs specifically associated with the relocation.

• The funds must be invested one year before the transfer date or within three years after it.

• For a period of three years from the date of acquisition, construction, or transfer, the claimant is not permitted to transfer the recently acquired, bought, built, or transferred asset.

This provision seeks to promote the relocation of industrial projects to Special Economic Zones by offering a favorable tax environment and stimulating company expansion and economic development.

Section 54GB

When transferring a long-term residential property, individuals or Hindu Undivided Families (HUFs) may claim exemption from capital gains tax under Section 54GB of the Income Tax Act, 1961. This exemption is valid provided that the net proceeds from the sale of the property are used to purchase equity shares from a qualified business that produces products or articles. Prerequisites for the Exemption are:

• A residential property, such as a home or piece of land, must be transferred to realize the capital gain.

  
  

• The capital gain must apply to an individual or Hindu Undivided Family (HUF).

  
  

• The net consideration amount should be invested in the subscription of equity shares of qualifying start-ups by the individual or HUF. Section 54 governs the exempted component if it is not entirely used.

  
  

• Upon receipt of the investment, the firm must use the share capital in newly qualifying assets within a year after the subscription date.

  
  

• Within five years of the purchase date, neither the company's assets nor its equity shares may be sold or transferred by the business, a person, or HUF.

  
  

Incentives for investing in qualified start-ups are provided by Section 54GB, which also offers a tax-efficient way to use capital gains from residential real estate transactions. This promotes innovation and entrepreneurship.

The below table presents the exemption details in a summarized manner:

Section	Asset Sold	New Asset Purchased	Exemption Amount
54	Residential property	Residential house (up to 2 if CG ≤ 2 Cr)	LTCG or cost of new asset (Max Rs. 10 Cr)
54B	Agricultural land	Agricultural land	LTCG or cost of new land
54D	Industrial land/building (compulsory acquisition)	Land/building for re-establishing industry	LTCG or cost of new asset
54EC	Land or building	NHAI/RECL bonds	Cost of new asset (Max Rs. 50L)
54EE	Long-term capital asset	Units notified by Govt	Cost of new asset (Max Rs. 50L)
54F	Any long-term capital asset (except residential house)	Residential house property	Cost of new asset (Max Rs. 10 Cr)
54G / 54GA	Industrial assets	Plant, machinery, land/building (shifted to rural/SEZ)	LTCG or cost of new asset

Capital Gain Account Scheme

The Indian Government, via the Ministry of Finance, has a system called as the "Capital Gain Account Scheme 1988." Taxpayers may benefit from an exemption from capital gains tax under this program. In order to get this benefit, taxpayers must deposit the net consideration or capital gains amount into a public sector bank before the deadline for completing their income tax return. To put it another way, it's a method wherein individuals may avoid paying Capital Gains tax by depositing their money into a designated bank account before filing their tax return.

Capital Gain Account Scheme

Budget 2023 and Section 54: 

Income is classified as capital gains if a capital asset is transferred during a particular year. The tax rules provide exemptions if capital gains are invested in certain ways specified in the applicable sections of the law to promote investment.

For such exemptions, Sections 54, 54EC, and 54F are often used. Recent changes, nonetheless, intend to cap these exemptions at Rs. 10 crore. This implies that the highest exemption that may be claimed will be set at ten crores, even if the investment amount surpasses ten crores.

For example, under Section 54, the maximum deduction that may be claimed is limited to 10 crores if the cost of the newly bought asset exceeds ten crores. Therefore, the exemption amount will be capped at ten crores in the event that the taxpayer acquires a new home for 18 crores and the gain amount is 18 crores.

Likewise, the highest deduction permitted under Section 54F is ten crores. Any amount invested beyond this limit will not be considered. A proviso has been included to guarantee that the net consideration amount exceeding Rs. 10 crores would not be taken into account while determining the exemption under this clause. The purpose of this modification is to provide consistency and a ceiling on the capital gains exemptions allowed under these provisions.

Amount of Exemption Under Section 54:

Following Section 54 of the Income Tax Act, the amount of long-term capital gains that are not taxed is the lesser of the capital gains from selling a residential property or the investment made in buying or building a new residential property. Any cash gains that are still left over will be taxed.

As an example:

Take the case of Mr. A, who sells his house for Rs. 50,000,000/-. His investment is Rs. 25,00,000/- in a brand-new house. This is how the math would work:

Particulars	Amount (Rs)
Capital gain on transfer of property	50,00,000.00
Less: Investment in new property	25,00,000.00
Balance - Taxable Capital Gains	25,00,000.00

In this instance, the exemption would be equal to the lesser of the investment in the new property (Rs. 25,00,000) or the capital gains (Rs. 50,00,000), for a total exemption of Rs. 25,00,000.

Comparison Between Various Sections of Exemption from Capital Gains

Section	Eligible Assessee	Property Type	Holding Period	Reinvestment Period	Exemption Conditions
54	Individual or HUF	Residential Property	> 3 months	12 months before or 24 months after	Sale proceeds < cost of new property; Difference considered long-term capital gains, 20% tax rate
54B	Individual or HUF	Agricultural Land (Non-rural)	2 years for agricultural use	Buy another within 2 years, not sell for 3 years	Exemption under Capital Gains Account Scheme; Deposit conditions apply
54D	Individual	Industrial Land/Building	> 2 years for industrial use	Reinvest within 3 years of compensation date	Exemption for compulsory purchases related to industrial undertaking
54EC	Individual or HUF	Long-term Capital Asset	N/A	Reinvest within 6 months in approved assets	Exemption for proceeds reinvested in designated assets, held for a minimum of 36 months
54EE	Individual or HUF	Long-term Capital Asset	N/A	Reinvest within 6 months	Exemption for reinvested transfer funds; Partial reinvestment not covered
54F	Individual or HUF	Capital Assets (excluding residential properties)	36 months	12 months before or 24 months after	Reinvest in residential property; Construct or acquire within 36 months; Own one property on sale date
54G	All Assessees	Assets used for industrial venture in urban areas	Short-term or long-term	Within 1 year before or 3 years after	Exemption for industrial relocation expenses; Amount determined by subtracting capital gain from investment
54GA	All Assessees	Capital assets of industrial business in urban area	Short-term or long-term	Invest 1 year before or 3 years after	Exemption for relocation to Special Economic Zone (SEZ); No transfer for 3 years from acquisition, construction, or transfer
54GB	Individual or HUF	Long-term Residential Property	N/A	Invest in equity shares within 1 year	Exemption for investing in qualifying start-ups; Holding period of equity shares for 5 years

FAQs

Q1. What is Section 54 of Income Tax Act?

Section 54 provides for exemption from capital gains which arise from the sale of a residential property in case the sale proceeds are reinvested in another residential property within a specified period.

Q2. Who is eligible for claiming exemption under Section 54 of the Income Tax Act?

Any individual/HUF selling a residential property and reinvesting the capital gain in another residential property can claim this exemption.

Q3. What are the conditions to claim exemption under Section 54?

The assessee, to claim this exemption, has to: 

• Sell a residential property.

• The capital gain is to be reinvested in a new residential property within 1 year before or 2 years after the sale, or construct a new residential property within a period of 3 years.

• The new property is to be held for at least 3 years.

Q4. How much exemption can be claimed under Section 54?

The maximum exemption that can be claimed under Section 54 is: lower of capital gains arising from sale and cost of new residential house.

Q5. Whether exemption under Section 54 can be claimed in respect of more than one residential house?

Yes, exemption can now be claimed for investment in two residential houses on satisfaction of other terms of Section 54B provided the capital gains do not exceed Rs. 2 crores, as introduced by Finance Act, 2019. Again this is once in a lifetime option.

Q6. What happens if I sell the new property within 3 years of purchase or construction?

If the new property is sold within three years, the exemption claimed under Section 54 shall be withdrawn and the amount added to the taxpayer's income in the year of sale.

Q7. Can Section 54 exemption be availed if the new property is under construction?

Yes, exemption is available if the new property is under construction, provided that the construction is completed within 3 years from the date of sale of the original property.

Q8. Is it necessary to reinvest the entire sale proceeds for availing exemption under Section 54?

No, it is not necessary that the whole sale proceeds must be reinvested. The exemption is available only on the amount of capital gains reinvested in the new residential property. Any balance amount will otherwise always end up being taxable.

Q9. Can I claim exemption under Section 54 if I purchase a property outside India?

Yes, after the amendment made by the Finance Act, 2014, you can claim exemption under Section 54 even if you purchase a residential property outside India. Prior to this, the exemption was available only for properties purchased within India.

Q10. Can I claim exemption under Section 54 if I already own multiple residential properties?

Yes, you can still claim the exemption under Section 54 even if you own multiple residential properties. There is no restriction on the number of properties owned by the taxpayer prior to claiming the exemption.

Q11. Can I claim exemption under both Sections 54 and 54F simultaneously?

No, you cannot claim exemption under both Sections 54 and 54F simultaneously for the same sale transaction. Section 54 applies to the sale of residential property, while Section 54F applies to the sale of any other long-term capital assets except residential property. Therefore, these sections are mutually exclusive based on the type of asset sold.

Q12. What happens if I am unable to reinvest the capital gain before the Income Tax Return filing due date?

If you are unable to reinvest the capital gain before the due date for filing the Income Tax Return, you must deposit the unutilized amount in the Capital Gains Account Scheme (CGAS). This amount should be used for the purchase or construction of a new residential property within the specified time limits. Failure to do so will result in the unutilized amount being taxed as capital gains.

Q13. Can I claim exemption under Section 54 if I sell an inherited residential property?

Yes, you can claim exemption under Section 54 even if the residential property sold was inherited or gifted. The only condition is that it should be classified as a long-term capital asset, meaning the property must have been held for more than 24 months before the sale.

Q14. Is Section 54 exemption available on the sale of commercial properties?

No, Section 54 applies only to the sale of residential properties. If a commercial property is sold, the exemption cannot be claimed under Section 54, but you may explore other sections such as Section 54F for reinvestment in residential property.

Q15. Can I avail exemption under Section 54 if I purchase a residential property in joint ownership?

Yes, you can claim exemption under Section 54 even if the new residential property is purchased jointly with another person. However, the exemption will be available only to the extent of your share in the property.

Q16. Is there any limit on the amount of capital gains eligible for exemption under Section 54?

No, there is no upper limit on the amount of capital gains that can be claimed under Section 54. However, if you choose to invest in two residential properties, the total capital gains should not exceed Rs. 2 crores (once in a lifetime option).

Q17. What are the tax implications if the new property is partially constructed when sold within 3 years?

If the new property is sold within 3 years of purchase or construction, even if partially constructed, the exemption claimed earlier under Section 54 will be withdrawn, and the capital gains previously exempted will be added to the sale amount for calculating the tax in the year of sale.

Q18. Can I use a home loan to purchase the new residential property and still claim exemption under Section 54?

Yes, you can use a home loan to finance the purchase of the new residential property and still claim exemption under Section 54. The exemption is based on the cost of the new property, irrespective of how it is financed (whether through own funds or a loan).