Section 54F of the Income Tax Act

The capital assets' definition is given u/s 2(14) of the IT Act, 1961. The capital assets as per ownership's period are divided into two categories - Short Term Capital Assets and Long-Term Capital Assets. The gain that arises from the transfer of long-term capital assets is considered a long-term capital gain, and in the same way, the gain that arises through the transfer of short-term capital assets is considered a short-term capital gain.

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There are many exemptions available in the IT Act against the gains of long term. Exemptions are included in Section 54, Section 54F, Section 54EC, and Section 54B.

What is Section 54F of the Income Tax Act?

The sale or transfer of capital assets like property attracts capital gains taxable in the taxpayer's hands. Under Section 54F of the Income Tax Act, 1961, tax exemption is allowed on the long-term capital gains earned from selling any capital asset other than a house property. Consider an example wherein you sell a capital asset like shares, gold, jewelry, bonds, etc., and reinvest the sale proceeds for purchasing or constructing a house property. These returns earned (which are later reinvested) on the sale of the capital asset are allowed as an exemption from tax under Section 54F. On the contrary, if the sale proceeds are reinvested in any other asset, the gains would become taxable, and you couldn't have taken the benefit of Section 54F. However, certain prescribed conditions need to be satisfied to claim this tax benefit.

Understanding' Net Consideration'

As per Section 54F of the Income Tax Act, the assessee has to reinvest the 'net consideration' to avail of exemption. The 'Net Consideration' of capital asset transfer means the full value of the consideration received for transferring the capital assets as reduced by some expenditure incurred completely and exclusively by connecting with such transfers. In this way,

Net Consideration = Full Value of Consideration (-) Expenditure

Net consideration that arises for transferring long-term capital assets that are invested in the following:

  • The net consideration is reinvested in the buying of one residential property one year before the transfer date or within two years after the transfer date.

  • The net consideration is reinvested in constructing 1 residential property in India in three years from the transfer date.

Conditions to Fulfill for Availing exemption u/s 54F

As per the Income Tax Act's Section 54F, exemption of capital gain is made available in the situation of long-term capital assets transfer against the investment one makes in a residential house. Some of the features to avail exemptions u/s 54F are mentioned below:

  • The exemptions u/s 54F are for Hindu Undivided Families and individuals.

  • The capital gain arises from transferring any long-term capital assets other than the residential house.

  • The assessee must not own more than one house

  • The house must be purchased within one year before or two years after the date at which such capital asset is sold. If the house is being constructed, the construction must be completed within 3 years from the sale of such a capital asset

  • The house must not be sold within 3 years, and else, the exemption is withdrawn

  • The exemption u/s 54F would be withdrawn if any other house is purchased (other than the one purchased) within one year from the date of selling a capital asset or construction of another house is made within three years

  • If the assessee is unable to utilize the sale proceeds for buying or constructing the house before the due for filing the income tax return in which such capital asset is sold, the procedure must be transferred to a 'capital gains account' with a bank.

The Portion of Capital Gain Exempted under Section 54F

Let us take an example to understand the extent of exemption under section 54F. An investor sold capital assets worth about Rs 50 lakh. The capital gains that arise from this sale are Rs 10 lakh. The investor re-invests this sale to proceed with the purchase/construction of the residential house. Now, there can be two scenarios:

  1. Scenario 1:  When the entire amount is reinvested

    When the investor reinvests the entire amount from the sale of assets in order to purchase or construct a residential house, he can claim an exemption on the total capital gains of Rs 10 lakh.

  2. Scenario 2: When a part of sale proceeds is reinvested

    In the situation when only a part of the net consideration is in investing in the construction or purchase of the residential property, then only the long-term capital gain's proportionate amount is exempted u/s 54F. The following formula can be used to calculate the proportionate amount:

    Exemption under Section 54F = (Amount Re-Invested / Net Consideration) * Long Term Capital Gain

    Continuing with the above example, if the investor reinvests Rs 40 lakh, then the capital gains exempted are calculated as (40 lakh /50 lakh) * 10 lakh = Rs 8 lakh.

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Circumstances in Which Exemptions U/S 54F are Not Available

The circumstances in which the exemption is not applied u/s 54F of the IT Act, 1961 are:

  • The taxpayer has more than one residential property on the date of transfer of the actual asset. However, the house that is brought to claim the exemption u/s 54F is exempted from this.

  • The taxpayer constructs an additional residential property within three years from the transfer date of the original asset. The constructed new asset to claim the exemption u/s 54F is exempted from this.

  • The taxpayer buys an additional house within one year from the transfer date of the original asset. This new asset bought to claim exemption u/s 54F is also exempted from this.

Consequences of Net Asset Transfer

In the situation of transfer of newly purchased constructed residential property or residential property before the expiration of 3 years period of its construction or purchase, as per the case at that time, then the capital gain that is exempted u/s 54F will be taxable under long term capital gain of the last year wherein the new asset is being transferred.

Account Scheme for Deposit of Capital Gain

When talking about net consideration, if it is not reinvested within the last date of return filing of income u/s 139, then the amount must be deposited in the scheme for the capital gain deposit account. The amount deposited in the capital deposit scheme account must be used to purchase or construct the residential property within a specific period.

If the deposited amount in the capital gain scheme of the deposit account is not utilized partially or completely within a specific period for construction or purchase, as the case can be, then in such a situation on the period's expiry, the utilized amount is treated as a capital gain.

Difference Between Section 54 and Section 54F

Section 54 Section 54F
Exemption on long-term capital gains for the sale of a residential property Exemption on long-term capital gains for the sale of any asset other than a residential property
Entire capital gains have to be invested to claim full exemption Entire sale proceeds have to be invested to claim full exemption.
If the entire capital gains are not invested, the remaining amount is taxed as long-term capital gains If entire net sale proceeds are not invested, the proportionate exemption is allowed u/s 54F
Ownership of one or more residential properties is not mandatory Ownership of more than one residential house at the time of sale of an old asset is not allowed
This once-in-a-lifetime exemption is available for investment in 2 properties if the capital gains do not exceed Rs. 2 crores No such exemption is available under section 54F

FAQ's

  • When can I claim exemption under section 54F of the Income Tax Act?

    A taxpayer can claim capital gains exemption under section 54F upon the sale of any long-term capital asset other than a residential house.
  • How do I claim 54F exemption?

    To claim exemption under section 54F, the taxpayer must purchase a house within one year before or two years after the date at which such capital asset is sold. If the house is being constructed, the construction must be completed within 3 years from the sale of such capital asset.
  • How is section 54F deduction calculated?

    The amount of money exempt from tax depends on how much of the sale proceeds you invest in the residential property. When a person reinvests the entire amount from the sale of assets in order to purchase or construct a residential house, he can claim an exemption on the total capital gains. When only a part of the net consideration is in investing in the construction or purchase of the residential property, then only the long-term capital gain's proportionate amount is exempted u/s 54F.
  • Will capital gains exemption under section 54F be applicable on sale of multiple properties?

    Yes, a taxpayer who sells multiple properties and invests all proceeds into one house can claim an exemption under section 54F, subject to conditions.
  • Can I claim capital gains exemption under section 54F by depositing in capital gains accounts scheme?

    You can claim exemption by depositing in the capital gains accounts scheme before the due date for filing the income tax return.
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