Section 54F of the Income Tax Act

Do you purchase capital assets like a plot of land, a house of property, or a bar of gold in order to form a funds’ source to fulfil your finance-related goals, plan your legacy, or your estate? Sometimes, in case of an emergency or any other purposes, you may require to sell these assets. The amount gained from the sale of these capital assets is called capital gains. 

 

Under section 2(14) of the Income Tax (IT) Act, 1961, the ‘capital assets’ are divided into 2 categories, namely, Long Term Capital Assets and Short Term Capital Assets. The profit gained from the transfer of short term capital assets is called ‘Short Term Capital Gain’ while that gained from the transfer of long term capital assets is referred to as ‘Long Term Capital Gain’.

 

Such profit is liable to tax and hence, the IT Act has several tax-saving benefits available against capital gains and are included in Sections 54, 54F, 54EC, and 54B. These help in the mitigation of your tax liability on such capital gains to ultimately raise your disposable income. 

As per Section 54F of the Income Tax Act, 1961, the long term capital gains earned by selling a capital asset except a house property can be exempted from tax subject to the given condition. The capital assets comprise bonds, gold, shares, and other such items. The condition prevails that the gains from the sale must be reinvested in either the purchase of the construction of a house property. If you meet this condition, the gains earned from the sale of the capital asset will be tax-free u/s 54F of the IT Act.

 

Few features to avail the exemptions under section 54F are as follows:

• These exemptions are applicable to the Hindu Undivided Families (HUFs) and the Individuals.

• The capital gain that has been earned must be through the transfer of long term capital assets except a house property.

• ‘Net Consideration’ arising from the transfer of long term capital assets invested in the following: 

 

1. ‘Net Consideration’ that is re-invested in the purchase of a residential house property in a year prior to the date of transfer or within 2 years post the date of transfer.

 

2. ‘Net Consideration’ that is re-invested in the construction of one house property in India within 3 years with respect to the date of transfer.

Example

Let’s take a look at the following example to help you understand calculation under Section 54F of the Income Tax Act in a better way:

Now, the amount of Rs. 10,00,00 that you receive on selling the shares is re-invested in the purchase or construction of a residential property. In such a case, according to Section 54F of the Income Tax Act, 1961, the capital gains of Rs. 4,00,000 earned will be tax-free.

 

However, if the amount of Rs. 10,00,000 is used to invest in any asset except a house property, the capital gains of Rs. 4,00,000 earned would be subject to tax. 

It is imperative that you understand the various terms mentioned under section 54F of the Income Tax Act, 1961, in order to reap the benefits of exemption. ‘Net Consideration’ is one such important term. 

 

The meaning of ‘Net Consideration’ of the capital assets’ transfer is the full value’s consideration that has been accrued by transferring the capital assets as mitigated by certain expenditures that were incurred exclusively by connecting with the transfer of such capital assets.

Hence, we can say that,

 

Net Consideration = Expenditure - Full Value of Consideration.

Under section 54 of the IT Act, 1961, tax exemption is allowed on the long term capital gains which are earned by selling the capital assets. However, this particular section is divided into Sections 54 and 54F. The major difference between the two sections is the kind of capital asset that has been sold.

 

If a house property is sold, the tax on long term capital gains will be exempted u/s 54 of the IT Act. However, if any capital asset except a house property is sold, the tax on long term capital gains will be exempted u/s 54F of the Income Tax Act.

There are certain common requirements for the applicability of both Sections 54 and 54F of the Income Tax Act, 1961. They are as follows:

• A new house property must have been constructed or purchased.

• The new house property must have been bought either a year prior or two years post the sale of the asset/property.

• The new house property must have been constructed within three years of its sale.

• If you are unable to invest the  mentioned amount in the manner as mentioned above prior to the tax filing date or one year after the sale date, whichever falls earlier, that amount must be deposited into either a public sector account or any other bank according to the Capital Gains Account Scheme, 1988.

• Only one residential property can be constructed or purchased. Under Section 54 of the IT Act, the exemption for two properties for the capital gains of up to Rs. 2 Crores can be claimed only once in a lifetime.

In order to claim the tax exemption as offered u/s 54F of the Income Tax Act, you are required to keep in mind certain requirements as mentioned below:

• Only Hindu Undivided Families (HUFs) and Individuals can claim the exemption.

• The proceeds received from selling the eligible capital assets must be used in any of the below mentioned ways: 

 

  1. Purchasing a new house property within one year prior to the sale.

  2. Purchasing a new house property within two years after the sale.

  3.Constructing a new house property within three years after the sale.

Portion of Capital Gains That is Exempted

Suppose that an investor sells assets worth Rs. 60,00,000 which includes the capital gains worth Rs. 10,00,000. He then re-invests this sum for the construction or the purchase of a house property, hence, the exempted capital gains are calculated as mentioned below:

• Scenario 1: When the entire amount of capital gains has been re-invested

In such a case, the tax on the total capital gains (here, Rs. 10,00,000) can be exempted. 

• Scenario 2: When only a portion of the capital gains has been re-invested

In such a case, the computation of the exemption on the capital gains will be done on the portion of the re-invested amount. For example, if the investor has re-invested Rs. 40,00,000, the exemption amount on the capital gains will be computed as (Rs. 40,00,000/Rs. 60,00,000)*Rs. 10,00,000=Rs. 6,67,000.

The circumstances in which the exemptions under section 54F of the Income Tax Act, 1961 will not be applicable are mentioned below:

• If you own more than 1 house property on the long term asset’s transfer date

• If you purchase another house property within one year from the date of transfer process of the long term asset

• If you get any house property constructed within a span of three years from the date of the transfer process other than the residential property bought to claim the tax-exemption under section 54F of the Income Tax Act, 1961.

Below mentioned example shows how you can calculate the tax exemption under section 54F of the Income Tax Act, 1961:

Hence, in the above-mentioned example, it can be concluded that the capital gains sum up to Rs. 6,50,000 while the sale proceeds go up to Rs. 22,50,000. If the entire sum of Rs. 22,50,000 is re-invested in a house property within the above-mentioned time limits, the tax will not be levied on the capital gains.

 

Note: You can perform the calculation of exemptions u/s 54F of the IT Act, 1961 by using the online calculators present on several websites.

The portion of the sale proceeds that you invest in the house property decides how much money will be exempt from tax. If the total amount of the sale proceeds is invested in the property, the entire capital gains will be exempt from tax under section 54F of the Income Tax Act.

 

However, if only a portion of the sale proceeds is invested in the house party, the exemption will be computed as follow:

 

Amount exempt = (Total capital gains*Amount invested in the house party)/Net sale proceeds

 

Note: You can use an income tax calculator to compute the exemption amount on tax under section 54F of the Income Tax Act, 1961.

The residential house property purchased by you by using the sale proceeds must not be transferred or sold for a span of 3 years with respect to the purchase date or the date of completion of construction. If you transfer or sell the house property within three years from the mentioned date, the capital gains amount that was claimed by you under section 54F of the Income Tax Act will be subject to tax in the sale/transfer year.

There are situations where you are not able to utilise the full or the partial sum of the sale proceeds in order to invest either in the construction or the purchase of a new residential property prior to the due date of tax filing. In such a case, the capital gain deposit scheme comes into effect to help you.

 

According to this scheme, the public sector banks enable you to deposit the proceeds from the sales into a capital gains deposit account. All you are required to do is deposit the sale proceeds into such accounts and then use it partially or completely to either purchase or construct a house property within the specified deadlines in order to be able to claim the tax exemptions.

Other than the exemptions mentioned under section 54F, there are several other deductions and exemptions which the IT Act allows. Few of them are as follows:

• Deductions u/s 80C

Tax deductions for various kinds of expenses and investments are allowed under this section. The avenues that are eligible for deduction comprise ELSS schemes, life insurance premiums, home loan principal repayment, NPS, SCSS, SSY, EPF, PPF, tuition fees paid for children, etc. You can also claim a cumulative deduction of an amount of up to Rs. 1,50,000 if you invest in the avenues included u/s 80C.

• Deductions u/s 80D

According to section 80D of the IT Act, 1961, the deductions for health insurance premiums are allowed. Those paid for family or oneself can be qualified for a deduction of an amount of up to Rs. 25,000. If you are a senior citizen, this limit can go up to Rs. 50,000. In addition to this, you can also claim a deduction of Rs. 25,000 if you pay the premium for your parents, and this limit can raise up to Rs. 50,000 if your parents are senior citizens. 

• Exemptions u/s 24(b)

If you take a home loan, the interest amount that is paid can be exempt from tax u/s 24(b). Please note that the exemption limit is Rs. 2,00,000.

 

Hence, it is important for you to understand the sections of the IT Act properly so that you can mitigate your tax liability and plan your finances effectively.