Unlock Real Estate and Capital Assets Tax Benefits: Section 54 & Section 54F Explained
Contents
- Introduction
- What are Section 54 and Section 54F of Income Tax Act?
- Section 54
- Section 54F
- Key Differences between Section 54 and Section 54F
- Exemption Limit
- How Section 54F Works?
- Some Basic Terminologies
- Scenarios 1
- Scenario 2
- Don’t sell your property yet!
- What is Capital Gains Account Scheme?
- Tax Rate on Long-Term Capital Gain and Short-Term Capital Gain
- Summary
- Why Section 54 and Section 54F Matter?
1. Introduction
With the ITR filing deadline for this financial year coming up on July 31, 2024, now’s the perfect time to plan your taxes wisely. Whether you've made profits from selling real estate, ESOPs, stocks, or other assets, Section 54 and Section 54F of the Income Tax Act can help you save on capital gains tax while also building assets. This blog will break down these sections, showing you how they work and how you can take advantage of them.
2. What are Section 54 and Section 54F of Income Tax Act?
Section 54
- Who can use it?: Individual or Hindu Undivided Family (HUF) taxpayers.
- What is it for?: Long-term capital gains from selling a residential property.
- How does it work?:
- Sell your residential property.
- Purchase another residential house either one year before the sale or within two years after the sale, or construct one within three years.
- The exemption applies to the amount of capital gains or the cost of the new property, whichever is lower.
Section 54F
- Who can use it?: Individual or Hindu Undivided Families (HUF) taxpayers.
- What is it for?: Long-term capital gains from selling any asset other than a residential house (like ESOPs, stocks, bonds, or other capital assets).
- How does it work?:
- Invest in a new residential house within one year before or two years after the sale, or construct one within three years.
- You must not own more than one residential house on the date of the sale of the original asset.
- The entire capital gain is exempt if the investment in the new house is equal to or greater than the net consideration from the sale. If it’s less, the exemption is proportionate. We'll cover this in more detail later.
Key Differences between Section 54 and Section 54F
- Type of Asset Sold: Section 54 is for residential properties, while Section 54F covers any long-term capital asset other than a residential properties.
- Number of Houses Owned: Section 54F requires you to not own more than one residential property other than the new one.
Exemption Limit
From 1st April 2023, the maximum deduction available under Section 54 and Section 54F is up to Rs. 10 crores. Earlier, there was no cap on the tax exemption made under both these sections.
3. How Section 54F Works?
Some Basic Terminologies
- Long Term Capital Gains (LTCG)
Investments that yield returns over an extended period (varying across asset classes) are referred to as long-term capital gains (LTCG). These can include returns from investments such as mutual funds and zero-coupon government bonds.
To illustrate, let's look at Arjun's example. Arjun, after working in his current startup for several years, had accumulated a sizeable amount of ESOPs.
When he recently exited, his LTCG was as follows:
- Net Consideration
According to Section 54F of the Income Tax Act, to benefit from the capital gains exemption, the assessee must reinvest the 'net consideration'. The 'net consideration' from the transfer of a capital asset refers to the total amount received from the transfer, minus any expenses incurred solely and exclusively for making that transfer. This means:
Net Consideration = Full Value of Consideration (-) Expenditure
Net Consideration = Rs. 50 lakhs
Let us continue with the above example of Arjun to understand the extent of capital gains exemptions under Section 54F.
For Example,
An Arjun sold capital assets worth about Rs 50 lakh. The capital gains that arise from this sale are Rs 30 lakh. The investor re-invests this sale to proceed with the purchase/construction of the residential house.
- Scenario 1: When the entire amount is reinvested
When an investor reinvests the entire amount from the sale of assets to purchase or construct a residential house, they can claim the long-term capital gains exemption on the total capital gains.
For instance, Arjun invested Rs. 60 lakhs in buying a residential house property for himself. Since this amount is greater than the net consideration amount of Rs. 50 lakhs, he can claim an LTCG exemption of the entire capital gains of Rs. 30 lakhs under Section 54F.
- Scenario 2: When a part of sale proceeds is reinvested
In the situation when only a part of the net consideration is invested in the construction or purchase of the residential property, then only the long-term capital gain's proportionate amount is exempted under Section 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
Using the above Example,
Let’s consider for this example Arjun bought a residential property for Rs. 40 lakhs which is less than the Net Consideration amount (Rs. 50 lakhs), the exemption would be calculated based on the invested amount.
4. Don’t sell your property yet!
If the new residential property is sold within three years from the date of purchase or construction, any exemption claimed under Section 54 or Section 54F will be subject to indirect taxation in the year the new property is sold. Typically, when a house is sold, the profit is treated as capital gains. However, if the new property is sold within three years, the Cost of Acquisition will be considered NIL, leading to an increase in taxable capital gains.
Let’s use Arjun’s example to illustrate this
Example:
Arjun sold his ESOPs in May 2023 for Rs. 50 lakhs, resulting in capital gains of Rs. 30 lakhs. He then purchased a residential real estate for Rs. 40 lakhs in June 2023.
Assuming Arjun sells this new residential property (purchased in June 2023) in January 2025 for Rs. 45 lakhs, here’s how the taxable capital gains are calculated:
Based on the facts mentioned above,
The taxable capital gains for Arjun. FY 22-23 (ESOPs sold in May 2023)
Note: Refer The Portion of Capital Gain Exempted under Section 54F - Scenario 2 for detailed explanation
Let’s consider two scenarios when the new house is sold within 3 years and when it is sold after 3 years from the date of purchase or construction:
- Scenario 1:
Now, if the new property for which deduction was claimed under Section 54F is sold on January 2025 (i.e. within 3 years from the date of acquisition - June 2023), hence it’s ‘cost of acquisition’ will be considered as NIL.
As a result, the entire Sale consideration will be considered as capital gains.
Here is the calculation of the taxation for the property sold in January 2025
- Scenario 2:
Had the property been sold after 3 years for the same price of Rs. 45 lakhs i.e. after June 2026, then in such case the cost of acquisition would be available as a deduction and capital gains would reduce.
5. What is Capital Gains Account Scheme?
If the asset is sold during the financial year, and the seller intends to purchase a new house property but hasn't done so yet because the 2 or 3 year time limit hasn’t expired, the assessee must deposit the amount of the gains into the Capital Gains Account Scheme at any public sector bank before the income tax return due date.
The expenses already incurred for the purchase or construction, along with the amount deposited in the Capital Gains Account Scheme, can be claimed as costs when seeking the deduction.
However, if the amount in the Capital Gain Account Scheme is not utilised within the specified time frame, it will be treated as income for the previous year in which the 3 year period from the date of transfer of the original asset expires (from the date of transfer of the original asset)
6. Tax Rate on Long-Term Capital Gain and Short-Term Capital Gain
| Type of Investment |
Holding Period for Long Term Capital Asset |
Long Term Capital Gain Tax
(LTCG) |
Short Term Capital Gain Tax
(STCG) |
Remarks |
> Stocks
> Unit Linked Insurance Plan (ULIP Funds)
> Equity Oriented Mutual Funds (Mutual Funds that invest at least 65% of their Portfolio in Stocks)
> Gold ETF |
> 1 years |
10% of gain |
15% of gain |
Long Term Gain Tax is only applicable if total Long-term gain/ profit in a financial year exceeds Rs. 1 Lakhs. |
> Privately held Stocks / Unlisted Stocks
> Immovable Property (like buildings, houses, and land) |
> 2 years |
20% with inflation indexation benefits |
Gains are taxed as per your applicable income tax rates |
- |
> Debt Mutual Funds
> Government and Corporate Bonds
> Gold ETF |
NA |
Gains are taxed as per your applicable income tax rates |
Gains are taxed as per your applicable income tax rates |
- |
| Gold |
> 3 years |
20% + 4% cess, with inflation indexation benefits |
Gains are taxed as per your applicable income tax rates |
- |
| Movable Property (like jewellery, royalty, and machinery) |
> 3 years |
20% with inflation indexation benefits |
Gains are taxed as per your applicable income tax rates |
Tax is not applicable for long-term profit reinvested in approved assets. |
Note: The above-mentioned taxes do not consist of a surcharge levied on your income tax. (After April 1, 2023 - Finance Bill 2023)
7. Summary
| Section 54 |
Section 54F |
| Long-term capital gains exemption available for the sale of a residential property |
Long term capital gains exemption for the sale of any asset other than a residential property |
| As per the Union Budget 2023, a maximum of Rs. 10 crores can be claimed for deductions under Section 54. |
In Section 54F, as per the latest Union Budget of 2023, the maximum tax exemptions are capped at up to Rs. 10 crores. |
| Entire capital gains have to be invested in claiming full exemption |
Entire sale proceeds have to be invested in claiming 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/ Sec 54F |
| Ownership of one or more residential properties is not mandatory |
Ownership of multiple properties (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 |
8. Why Section 54 and Section 54F Matter?
Tax Savings
- Reduce Tax Burden: These sections help taxpayers defer or avoid capital gains tax by reinvesting in residential property. This can greatly lower your tax liability, particularly if you’ve made significant gains.
Encouragement of Real Estate Investment
- Promote Property Investment: With tax incentives for reinvesting in residential properties, these sections motivate taxpayers to invest in real estate, boosting the housing market and the economy.
Flexibility and Financial Planning
- Smart Reinvestment: The ability to reinvest gains in new properties provides more options for financial planning. Whether you’re upgrading your home, buying a rental property, or planning for the future, these sections offer valuable opportunities.
Support for Long-Term Investments
- Build Long-Term Wealth: Real estate is generally a stable, long-term investment. By using these sections, you can grow and diversify your asset portfolio, enhancing long-term financial security.
By leveraging Sections 54 and 54F of the Income Tax Act, you can smartly manage your taxes while building valuable assets. Whether you’re selling a house, ESOPs, stocks, or other capital assets, these provisions offer significant tax savings and investment opportunities. Make informed decisions and let your money work for you!
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