Section 54 of the Income Tax Act | Updated Exemption Guide

Section 54 of the Income Tax Act provides tax exemption on long-term capital gains from the sale of a residential property, if the seller reinvests the amount in another residential house in India. This helps taxpayers save tax legally while buying a new home.

Let’s understand this with the example of Mr. Verma. He sold his old house for ₹80,00,000 after holding it for over 3 years. His purchase price was ₹40,00,000, giving him a long-term capital gain of ₹40,00,000. Within 1 year, he bought a new house worth ₹35,00,000.

Here’s how the exemption works:
 

Mr. Verma saved tax on ₹35,00,000 by using Section 54 exemption.

Tax on Property Sale: What Section 54 Says

When you sell a residential property, the entire sale amount is not taxable. Only the profit is, the difference between the sale price and the original cost, is taxed. This profit is known as capital gain.

A house is considered a capital asset under Section 2(14) of the Income Tax Act. This includes any kind of property—movable or immovable, tangible or intangible—held by a person.

For tax purposes, capital assets are classified based on how long you hold them:

• Short-term capital asset: Held for up to 24 months
• Long-term capital asset: Held for more than 24 months

For example, Ravi bought a flat in 2018 for ₹30,00,000 and sold it in 2024 for ₹55,00,000. He held the property for more than 24 months, so it is treated as a long-term capital asset.

Ravi must pay tax only on the ₹25,00,000 gain, not the entire sale amount.

Why Long-Term Capital Assets Offer More Tax Benefits

When an asset is classified as a long-term capital asset, the taxpayer enjoys key tax benefits. One major benefit is the option to use indexation, which adjusts the purchase cost of the asset for inflation. This reduces the taxable gain and lowers the tax payable.

Also, many capital gain exemptions under the Income Tax Act, such as those under Section 54, apply only to long-term capital assets.

From 23rd July 2023, taxpayers selling land or buildings can now choose one of two tax options:

• Pay tax at 12.5% without indexation, or
• Pay tax at 20% after claiming indexation.

This choice helps taxpayers plan their taxes better, depending on how long they’ve held the asset and how much inflation has impacted its value.

How to Claim Capital Gains Exemption Under Section 54

Under Section 54 of the Income Tax Act, an individual or a Hindu Undivided Family (HUF) can claim capital gains tax exemption if they sell a residential property and reinvest the gains in another residential house in India.

This benefit is not available to companies, partnership firms, LLPs, or any other type of business entity. To claim this exemption, the seller must meet all the following conditions:
 

How Much Tax Exemption Can You Claim Under Section 54?

Under Section 54 of the Income Tax Act, the exemption amount is the lower of:

• The long-term capital gain from the sale of the residential property, or
• The amount invested in buying or building a new residential house.

If the entire capital gain is not reinvested, the balance amount becomes taxable.

Example:

Mr X sells his house (villa) and reinvests part of the sale proceeds in a new house.
 

Mr X can claim an exemption of ₹20,00,000, as it is the lower of the capital gain and the new investment.

What Happens If You Sell the New House Within 3 Years?

When you claim tax exemption under Section 54 and sell the new residential house within 3 years, the earlier exemption becomes taxable. This rule ensures the benefit is used only for long-term property investment.

Let’s understand this with two cases:

Case 1: New House Costs Less Than Capital Gains

If the new house costs less than the capital gains and you sell it within 3 years, the cost of acquisition becomes Nil, and the entire sale amount becomes taxable.

Example – Mr Y
 

Since the house was sold within 3 years, Mr Y paid tax again on the full sale amount.

Case 2: New House Costs More Than Capital Gains

If you invest more than your capital gains, and later sell the house within 3 years, you will reduce your house's original cost by the earlier exempt capital gain. The balance becomes your cost of acquisition.

Example – Mr Z
 

Note:-

This rule discourages short-term resale of the new property after availing the exemption.

Section 54 vs Section 54F 

The Income Tax Act provides exemptions on long-term capital gains under Sections 54 and 54F to reduce tax liability. Here's how they differ:
 

Conclusion

Section 54 of the Income Tax Act helps you save tax on long-term capital gains earned from selling a residential house. You must reinvest the gains into a new residential property within a specific time. If you meet the conditions, you can claim full or partial exemption. But if you sell the new house within 3 years, the exemption will be reversed, and you’ll need to pay tax.

FAQ’s

1. Who can claim exemption under Section 54?
Only individuals and Hindu Undivided Families (HUFs) can claim this exemption when they sell a residential house.

2. What type of asset qualifies for exemption?
You must sell a long-term residential house property and reinvest in another residential house in India.

3. What is the time limit to buy a new house?
You must buy a house within 1 year before or 2 years after the sale, or construct it within 3 years.

4. Can I buy two houses to claim the exemption?
Yes, but only once in your lifetime and only if the capital gain is not more than ₹2 crore.

5. What happens if I sell the new house early?
If you sell the new house within 3 years, the earlier exemption becomes taxable as capital gains.

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