The Income Tax Act, 1961 grants exemption of capital gains arising from the transfer of residential house property under section 54.

Conditions –

1. The house property is a residential house whose income is taxable under the head “Income from House property” and transferred by an individual or HUF. It is not necessary that only one property is transferred.
2. The house property (may be self occupied or let out) is a long term capital asset (i.e., it must be held for a period of more than 36 months before sale or transfer).
3. The assessee has purchased a residential house within a period of one year before the transfer (or within 2 years after the date of transfer) or has constructed a residential house property within a period of three years after the date of transfer. In the case of compulsory acquisition, the above time-limit of 1-year, 2-year and 3-year is applicable from the date of receipt of compensation (whether original or additional).
4. The house property so purchased or constructed has not been transferred within a period of three years from the date of purchase or construction.

Other relevant points to be kept in mind:

• Construction of the house should be completed within 3 years from the date of transfer. Date of commencement of construction is irrelevant and construction may be commenced even before the transfer of the house.
• Case of allotment of a flat under the self-financing scheme of DDA (or similar schemes of co-operative societies and other institutions) is treated as construction of house.
• If the whole of the consideration is paid and possession of the house is obtained, the exemption contemplated u/s 54 is clearly attracted. If the substantial amount is paid in terms of purchase agreement within the stipulated period, the exemption u/s 54 is available even if the possession is handed over after the stipulated period.
• Nowhere it has been mentioned in sec 54 that the same funds must be utilized for the purchase of another residential house; requirement of law is that the assessee should purchase residential house within the specified period and the source of funds is quiet irrelevant.
• The exemption is not limited to acquisition of one house property.

Amount of Exemption – If Amount of Capital Gain is less than the cost of the new house property – Entire amount of capital gains is exempt from tax. If Amount of Capital Gain is greater than the cost of the new house property – The difference between the amount of capital gains and the cost of the new house is chargeable to tax as capital gains.

Consequences if the new house is transferred within three years –

If the new house property is transferred, within a period of three years from the date of its purchase or construction, the amount of capital gain arising therefrom, together with the amount of capital gains exempted earlier, will be chargeable to tax in the year of sale of the new house property.
To attain this, it has been provided that if the new house is transferred within three years from the date of its acquisition or date of completion of construction, the amount of exemption u/s 54 shall be reduced from the cost of acquisition of the new house, while calculating short-term capital gain on the transfer of the new asset.

Scheme of deposit in respect of Exemption u/s 54 – Where the amount of capital gain is not appropriated or utilised by the assessee for purchase or construction of the new residential house before the due date of furnishing the return of income, it shall be deposited by him on or before the due date of furnishing the return of income, in the Deposit Account in any branch (except rural branch) of a public sector bank in accordance with the Capital Gains Accounts Scheme, 1988.

The amount already utilised for the purchase or construction of the new house together with the amount so deposited shall be deemed to be the amount utilised for the purchase of a new house u/s 54.

If the amount deposited is not utilised shall be treated as long-term capital gain of the previous year in which the period of three years from the date of transfer of the original asset expires. In such cases the assessee shall be entitled to withdraw such amount in accordance with the aforesaid scheme.

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