The Income Tax Act contains exemption provisions from long-term capital gains tax if the taxpayer were to invest in a residential house property. This provision has helped countless taxpayers to first own and thereafter move into bigger and better houses at the cost of the exchequer by saving income tax on their long term capital gains.
There are two sections in the IT Act that deal with the exemption - section 54 and section 54F. The first one deals with capital gain on sale of one house property and reinvestment of the capital gains of that property into another residential house property.
The second section deals with capital gains on any asset other than house property (for example gold) and investment of the net consideration (sale proceeds reduced by the direct expenses on the sale).
In other words, the second section demands investment of a larger amount into the property compared to the first one where only the capital gain is to be invested in the property. Let us understand these two sections with examples.
Mr A who had purchased his flat in 1990 for Rs 10 lakh (Rs 1 million) sold it for Rs 25 lakh (Rs 2.5 million) in 2005. He is required to invest only Rs 15 lakh (Rs 25 lakh less Rs 10 lakh) in another residential property under section 54.
Compare this with Mr B's situation who had purchased jewellery for Rs 10 lakh for his wife in the year 1990 and sold it in 2005 for Rs 25 lakh. Mr B is required to invest Rs 25 lakh under section 54F in another residential property in order to save tax on the identical amount of capital gain of Rs 15 lakh (Rs 1.5 million).
The time limit for investment in the other residential property is identical under both the sections:
For outright purchase of residential property it has to be within a period of one year before the sale or two years after the sale; or within a period of three years after the sale construct the residential house. The rationale behind the different time limits is that an outright purchase takes lesser time compared to building a house.
Needless to state is the fact that the reinvestment must be in a residential house property. By implication commercial property or vacant plot of land are not eligible. Similarly, short term capital gains enjoy no exemption. So if you sell your house within 36 months of purchase, you will not have any tax benefits.
If the long-term capital gain or the net consideration under the above two sections is not invested in the purchase of a new house within one year before the date of sale of the earlier house or other asset; or not utilised for purchase or construction of the new house before the due date of filing the return of income, this capital gain or net consideration is required to be deposited, before filing the return, in a separate deposit account.
The central government has designated nationalised banks like State Bank of India, Bank of India, Bank of Baroda etc to open such a special deposit account. From these deposits the taxpayer is expected to issue cheques for the purchase or construction of the property. These deposits earn a nominal interest also.
There is one more aspect of section 54, which is a subject matter of some controversy with the Income tax Department. The controversy centres around the use of the word 'a' before residential house while referring to the reinvestment of the gain.
To illustrate: Mr A, having a large house, sells it for Rs 2 crore (Rs 20 million) making a capital gain of Rs 1 crore (Rs 10 million). Out of the capital gain of Rs 1 crore, Mr A purchases two flats each of Rs 50 lakh (Rs 5 million) on the seventh and eighth floors of a building within the time laid down by the law.
Strict interpretation of Section 54 leads to the view that Mr A will be entitled to exemption of only Rs 50 lakh being purchase of 'a' residential property on the seventh floor.
In other words, the purchase of the second residential property on eighth floor will not be eligible. He should have purchased one large flat on either seventh or eighth floor. This view of the Income tax Department has been recently upheld by the Income Tax Appellate Tribunal, Pune Bench. Coming to section 54F, the section permits investment of consideration in maximum two properties and not more.
The writer is a chartered accountant