Capital asset under Section 54

An individual and a Hindu Undivided Family (HUF) can avail tax exemptions from capital gains invested in eligible transactions such as purchasing or constructing new assets. only a person living in India can apply for tax exemption under this section to save on capital gains. 

A person or a family can sell immovable assets and make gains tax-free if the transaction is eligible under this section, as suggested under Section 54.

Types of capital gains

It is a property owned by an individual assessee or a HUF that is related to business or simply ownership of assets. There are different types of assets such as immovable, tangible, moveable, intangible, circulating, and fixed.  

Based on the period of holding capital gains is categorized into two types, ‘long-term’ and ‘short-term’ in the Income-tax Act, 1961.

The short-term capital gain (STCG) or loss is considered when the property is transferred before the expiry of 36 months. If the property is sold after 36 months, it will be considered in long-term capital gain (LTCG) or Loss.

Further, STCG will be taxed at income tax slab rates applicable to the taxpayer and LTCG would be subject to tax at 20% with indexation benefit.

How to save income tax on capital gains from house property

Tax exemption under section 54 by investing in another residential house

Any individual taxpayer who receives capital gains from the sale or transfer of a house can claim exemption under this section. 

Received gains must be invested in another residential house property in India. The available tax exemption would be lower of the following amounts:

  • Investment made in the new residential house property
  • Amount of capital gain

The capital gain must be invested or used to purchase the new house property within one year before or two years after selling the old residential property. The new property should be constructed within three years of the sale of the old property.

In case capital gains are derived from the compulsory acquisition of house property by the government, the period for buying or constructing a new house will be determined from the date of compensation receipt.

However, if the new residential property is sold before the lock-in period of 3 years, the tax exemption under section 54 will expire. The amount will be reduced from the cost of newly acquired property sold, and the capital gains will be computed in accordance with that. 

For instance, a taxpayer sells the property before the lock-in period of 3 years and claims an exemption of Rs. 20 lakhs by investing Rs. 60 lakhs in a new property. The cost of the new property would be taken as Rs. 40 lakhs for the purpose of computing capital gains instead of the original cost of Rs. 60 lakhs.

Tax exemption under section 54 applies only to house property purchased/constructed in India. No such exemption can be claimed for house property purchased outside India.

Typically, one-house property is eligible for tax exemption. However, FY 2020-21 exceptions made tax exemption available for two-house properties if the total capital gains do not exceed Rs 2 crore. The taxpayer can only avail himself of this exemption once in his lifetime.

Tax exemption under section 54EC by investing in specified bonds

Individuals can claim tax exemption under section 54EC regarding LTCG from selling any residential or commercial property. To avail of the tax exemption, they are required to invest in bonds that the government notifies. Such specified bonds have a lock-in period of 5 years and if it is sold before the expiry of 5 years, then the tax exemption will lapse.

Within a period of 6 months from the date of sale/transfer of such property, investment in specified bonds is required to claim tax exemption. The amount of such tax exemption must be less than the following:

  1. Capital gain; or
  2. Amount invested; or
  3. Rs. 50 lakh

Rural Electrification Corporation (RECL), Indian Railway Finance Corporation (IRFC), and Power Finance Corporation Ltd (PFCL) are the currently specified bonds in which the taxpayer can invest. 

Tax exemption under section 54G by investing in a specified company

This section allows individual taxpayers to claim tax exemption on LTCG gained from sale of house property. Suppose net sale consideration received on the sale of the property is invested in equity shares of an eligible specified company (usually a startup). In that case, it is eligible to claim the tax exemption. Additionally, the company must utilize the sum to purchase certain machinery and plant, office equipment, or any vehicle for official use within a period of 1 year.

The investment must be made on or before the due date of income tax return filing. For instance, if the house is sold in February 2022, the investment must be made in the startup/company on or before July 31, 2022. The allowed exemption will be proportionate to the amount so invested if the entire net sale consideration is not utilized for investment purposes.

Other things to keep in mind when claim capital gains exemption

Due to practical difficulties, taxpayers are sometimes unable to make the aforementioned investments within the specified time period. The Capital Gains Account Scheme (CAGS) was introduced to ease such concerns. 

Taxpayers who are unable to invest their money within the required timeframe can deposit their money in a CGAS account to avail the tax exemption.

Taxpayers must only use a CAGS account if they are willing to invest their capital gains in another house or property or company/start-up to obtain a tax exemption. 

CGAS deposit must be made on or before the ITR filing deadline (July 31) or the actual filing date, whichever is earlier. The money deposited in this scheme can be withdrawn at any time to invest in equity shares of an eligible specified company or another residential property. However, the capital gains will be taxable if the taxpayer fails to invest from CAGS within the prescribed time limits i.e. 2 years for purchasing a new property or 3 years in case of construction of a new property.

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