Under the Indian Income Tax, any profit or gain arising from the transfer of capital assets is taxed at special rate under the head “Capital Gains” in the year in which such transfer took place. Tax on capital gain arising from sale of long term house property can be saved if the amount of capital gain is invested for the purchase or construction of the residential property.

What does the provision say???

Any capital gain arising from the transfer of buildings or lands appurtenant thereto and being a residential house, the income of which is chargeable under the head “Income from house property” shall be exempt to the extent such capital gain is invested in the purchase of another residential house property within one year before or two years after the date of transfer or constructed a residential house property, within a period of three years from the date of transfer, provided the residential house purchased or constructed should not be transferred within a period of 3 years from its acquisition.

If the new house is transferred within a period of 3 years from its acquisition, then for the purpose of computing capital gain on such transfer, the cost of acquisition of this house property shall be reduced by the amount of capital gain exempted earlier under this section and the capital gain arising on this transfer will always be a STCG.

The amount of the capital gain which is not utilized towards the purchase of the new asset made within one year before the date on which the transfer of the original asset took place, or which is not utilized for the purchase or construction of the new asset, shall be deposited before furnishing such return in an Capital Gain Account Scheme. The amount, if any, already utilized by the assessee for the purchase or construction of the new asset together with the amount so deposited shall be deemed to be the cost of the new asset.

Other aspects which may help you in better understanding of the above provision:

What, if the amount deposited in Capital Gain Account Scheme not utilized for the purchase or construction of the property?

If the amount deposited in the said scheme is not utilized wholly or partly for the purchase or construction of the new asset within the period specified then, the amount not so utilized shall be charged to tax as the income of the previous year in which the period of three years from the date of the transfer of the original asset expires; and the assessee shall be entitled to withdraw such amount in accordance with the scheme aforesaid.

Will the expenses incurred to make the semi-finished house habitable is also treated as investment in house, where the capital gain is invested in purchase of semi-finished house?
In such case, the amount will have to be invested on flooring, wooden work, sanitary work etc to make it habitable. The investment in house would be complete only when such house becomes habitable. So, such expenditure is also considered as in purchase of house.

We try to keep the posts as short and readable as possible, thus we have segregated this post in two parts. Please check part II for more on this subject.

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