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Section 54F Of Income Tax Act: Exemption Of Capital Gains

You might buy capital assets to create a source of funds for your financial goals, to plan your estate and also to plan your legacy. However, when you sell these capital assets, the profit that you gain from such a sale is called capital gain. Such a gain is chargeable to tax, but the Income Tax Act 1961 allows tax-saving benefits on such gains. These benefits help lower your tax liability on capital gains and increase your disposable income.

One such tax-saving section of the Income Tax Act, 1961 is Section 54F that deals with the capital gains earned from the sale of capital assets. Let’s have a look at what this section is all about.

What are capital assets?

Before we get into the details of Section 54F, it is important that you understand what capital assets are. Capital assets include all kinds of property that a person holds, which may or may not be connected to his/ her profession or business. A piece of land, a house, trademarks, vehicles, machinery, patents and jewellery can also come under the umbrella of capital assets.

However, you need to bear in mind that the following do not fall into the category of capital assets. :

  • Raw material or consumables that are held for business
  • Clothes, furniture held for personal use
  • Rural agricultural land.

For example, Ravi Khanna purchased gold in May 2022 for INR 10 lakhs and sold it in September 2023 for INR INR 15 lakhs. The gold will be treated as a short-term capital asset, and the INR 5 lakhs profit will be treated as capital gain and will attract tax.

Example: Jai Rathore is a property dealer. He purchased a flat worth INR 25 lakhs in March 2021 and sold it for INR 30 lakhs in June 2022. Because he made the sale/ purchase as a part of his business, it would not be treated as a capital asset. The profit will be treated as his business income and not a capital gain.

For taxation purposes, capital assets can be further classified into two types:

  1. Short-Term Capital Asset:
    A short-term capital asset, STCA, is an asset that you hold for a period of 36 months or less immediately preceding the date of its transfer.
  2. Long-Term Capital Asset:
    A capital asset that you hold for 36 months or more immediately preceding the date of its transfer is considered to be a long-term capital asset, LTCA.

Note:

  • For Assets such as preference shares or equity, that are listed in a recognised Indian stock exchange, the holding period is considered as 12 months rather than 36 months
  • In the case of unlisted shares of a company, the period of holding is considered 24 months, rather than 36 months.

What is Section 54F of the Income Tax Act?

Section 54F of the Income Tax Act, 1961, is a section that allows tax exemption on the long-term capital gains earned from selling a capital asset other than a house property. So, if you sell a capital asset like shares, bonds, jewellery, gold, etc. and reinvest the sale proceeds towards the purchase or construction of a house property, the returns earned on the sale of the capital asset would be allowed as an exemption from tax under Section 54F.

Number of shares that you own10,000
Purchase price of the sharesINR 50
Cost of buying the sharesINR 5 lakhs
Selling price of the sharesINR 100
Amount received on selling the shares100*10,000 = INR 10 lakhs
Capital gains earned10 lakhs – 5 lakhs = INR 5 lakhs

Now, you invest the sale proceeds of INR 10 lakhs into a house property.

In this case, according to Section 54F of the Income Tax Act, the capital gain of INR 5 lakhs would not be taxed in your hands.

If, however, you use the amount of INR 10 lakhs to invest in any other asset, the gains of INR 5 lakhs would become taxable in your hands.

This is how Section 54F works.

Meaning of Net Consideration under Section 54F

It is very important to understand various terms of section 54 F to avail of the exemption.

According to section 54 F, “Net Consideration” means- the full value of the consideration received or accruing from the transfer of the capital asset as reduced by any expenditure that was wholly and exclusively incurred in connection with the transfer of the capital asset. In simpler words, “Net Consideration” is the total value obtained after the sales process of your asset after deducting any incurred expenditures.

Union budget 2023-24 on Section 54F of income tax:

In the Union budget 2023-24, Finance Minister Mrs Nirmala Seetharaman proposed certain provisions that deal with capital gains. We know that Section 54 exempts long-term capital gains on the sale of a residential property if the indexed capital gain (long-term) is used for purchasing or constructing a house in the given time frame. Similarly, Section 54F provides an exemption from any long-term capital gain you make on the sale of an asset apart from a house (residential), provided the net consideration that is received is used to either buy or construct a house within the given time frame.

As of now, there is no limit on the amount for which you can claim an exemption from the LTCG when making an investment in a residential house. However, the budget proposes to put an INR 10 crore cap, only under which you can get a tax exemption under Section 54 or 54F. This step has been taken to mitigate the shortage of housing and also to give momentum to house building.

The finance department claimed high net-worth assesses claiming huge deductions, thus defeating the very purpose. Therefore, if you are planning to reinvest the sale proceeds that exceed INR 10 crores, you may want to think again as it may not fetch you tax benefits post-April 1, 2023.

Difference between Section 54 and Section 54F

The whole of Section 54 allows tax exemption on long-term capital gains earned from selling capital assets. However, the section is divided into Section 54 and Section 54F. The main difference between these two sections is the type of capital asset sold. If you sell off a property or house property, the tax exemption on long-term capital gains would be allowed under Section 54. However, for any other capital asset, i.e. except a property, the long-term capital gain is exempted under Section 54F of the Income Tax Act.

Common requirements of Sections 54 & 54F
For the applicability of Sections 54 and 54F, there are some requirements that need to be fulfilled, such as:

  • Only an individual or HUF can claim Section 54
  • A new residential house has to be either purchased or constructed
  • The new house must be bought either one year before or two years after the sale of the asset
  • With effect from Assessment Year 2021-22, an exemption in case of 2 residential properties can also be made, only if the long term capital gains do not exceed INR 2 crores. Also, bear in mind that if this option is exercised, then the same cannot be claimed again for any other assessment year
  • The house should be purchased/ constructed in India only.

Requirements to claim an exemption under Section 54F

To claim a valid exemption under Section 54F of the Income Tax Act, you have to fulfil some basic requirements. These requirements are as follows

  • The exemption is available to individuals and Hindu Undivided Families (HUFs)
  • To claim the exemption, the sale proceeds should be used in the following manner
    • To buy a new residential property one year before the date of sale of the asset
    • To buy a residential property within 2 years from the date of sale of the asset
    • To construct a residential property within 3 years from the date of sale of the asset
  • If you invest a part of the sale proceeds in the property, the full exemption would not be allowed. In such cases, the exemption would be available on a proportionate basis. The amount of exemption would be calculated as follows
    • Capital gains * amount invested / net consideration
  • For instance, let’s take the above-mentioned example again
Number of shares that you own10,000
Purchase price of the sharesINR 50
Cost of buying the sharesINR 5 lakhs
The selling price of the sharesINR 100
Amount received on selling the shares /net consideration100*10,000 = INR 10 lakhs
Capital gains earned10 lakhs – 5 lakhs = INR 5 lakhs

Now, suppose, out of INR 10 lakhs, you invest only INR 6 lakhs in house property. In this case, the capital gain of INR 5 lakhs would not be fully tax-exempt. The exempted amount of gain would be calculated as follows –
Capital gains * amount invested / net consideration = 5 lakhs * 6 lakhs / 10 lakhs = INR 3 lakhs

So, for your capital gain of INR 5 lakhs, INR 3 lakhs would be exempted from tax but INR 2 lakhs would be taxed in your hands at your slab rates.

The eligible amount of deduction under Section 54F

The amount of deduction under Section 54F of the Income Tax Act depends on the amount invested towards the residential property. If you invest the entire proceeds towards a house property, the whole of the amount can be claimed as an exemption under Section 54F. If, however, you invest a part of the amount towards the house property, the exemption would be reduced proportionately.

Let’s understand with an example. Suppose you sell a capital asset for INR 50 lakhs and earn a capital gain of INR 5 lakhs. Now, let’s take two scenarios

Scenario 1 – You invest the entire amount of INR 50 lakhs into a house property.

Exemption available – Since you have invested the entire amount, you can claim the entire amount of long term capital gain, i.e. INR 5 lakhs, as an exemption.

Scenario 2 – You invest INR 35 lakhs towards the house property. You also incur INR 2 lakhs in selling expenses. In this case, the exemption would be calculated as follows

Exemption = long term capital gain * amount that is reinvested / net consideration

= 5 lakhs * 35 lakhs / (50 lakhs – 2 lakhs)

= INR 3.65 lakhs (rounded-off)

Circumstances in which Exemptions Section 54F is not Available

In any of the following scenarios Section 54F is not applicable.

  1. If someone owns more than one residential house on the date of transfer process of the long term asset, then the request for tax exemption on gain is not valid according to section 54F
  2. If someone buys another residential house within one year from the transfer process of the long term asset
  3. If someone constructs one more residential house (within three years from the transferred process date) other than the house purchased to claim exemption under 54F

The consequences of transferring the asset

The house property that you buy or construct using the sale proceeds of the capital gain should not be transferred or sold within 3 years of purchase or completion of construction. If you transfer the house property within 3 years, the exemption allowed under Section 54F of the Income Tax Act would be withdrawn and the capital gains incurred would become taxable from the year that the transfer takes place.

Capital gain deposit account scheme

There might be times when you are unable to use the full or partial amount of the sale proceeds to invest in the purchase or construction of a new house property before the tax filing due date. In such cases, the capital gain deposit account scheme can come to your aid. Under this scheme, public sector banks allow you to deposit the sale proceeds in a capital gain deposit account. You can deposit the amount in such accounts and then use the proceeds completely or partially to purchase or construct a residential house property within the stipulated timelines to claim tax exemption.

Alternative methods to save income tax

Besides the exemption available under Section 54F, there are various other exemptions and deductions that the Income Tax Act, 1961 allows. Some of these ways to save taxes include the following

  • Deductions under Section 80C
    This section allows tax deductions for different types of investments and expenses. Some of the eligible avenues include life insurance premiums, ELSS schemes, tuition fees paid for children, home loan principal repayment, PPF, EPF, NPS, SSY, SCSS, etc. You can claim a collective deduction of up to INR 1.5 lakhs by investing in Section 80C avenues.
  • Deductions under Section 80D
    Section 80D of the Income Tax Act, 1961 allows deductions for health insurance premiums. Premiums paid for self and family qualify for a deduction of up to INR 25,000. This limit increases to INR 50,000 if you are a senior citizen. Moreover, if you also pay the premium for your parents, you can claim an additional deduction of INR 25,000 which also increases to INR 50,000 if your parents are senior citizens.
  • Exemption under Section 24(b)
    If you avail of a home loan, the interest paid is allowed as an exemption under this section. The limit of exemption is INR 2 lakhs

So, understand how you can reduce your tax liability using Section 54F of the Income Tax Act and also other sections of the Income Tax Act, 1961 and then plan your taxes effectively.

FAQ’s

As a taxpayer, you need to purchase a house within 2 years of the date on which the asset was sold. In case you are using the money to construct a house, you need to ensure that the construction is completed within 3 years of the sale.

The deduction depends on the sale proceeds that you plan to invest in the new residential property. In case you plan to invest the entire amount to buy or construct a residence, you may be eligible for a full claim. On the other hand, if only a part is being invested, then in that case, only the LTCG’s proportionate amount can be claimed.

Yes. If you sell more than one property and then use all the proceeds to buy/ construct a house, you can still be eligible for a Section 54F exemption.

If you wish to claim capital gains exemption under section 54F by depositing in the capital gains accounts scheme, then make sure you do that before the ITR filing due date.