Section 54 of Income Tax Act: Meanings, Types, Benefits & Capital Gain Deductions

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Invest in real estate now, hold it for a few years, and earn money by selling it at a higher price. This strategy is the success mantra for many individuals looking for less risky, less volatile, and more secure investment options. However, when designing this strategy, most investors often forget about tax planning. For instance, if a residential property seller uses the sale amount to buy or construct another residential property, they become eligible for tax benefits under Section 54 of the Income Tax Act.

Below, let’s discuss Section 54 in detail.

What is Section 54 of the Income Tax Act?

Section 54 is a special tax exemption one may enjoy on capital gains. Individuals and Hindu Undivided Families (HUFs) can claim a deduction under Section 54 when selling their residential property and purchasing or constructing another residential property using the sale amount. This tax exemption applies only to the sale amount used for acquiring the new property.

Under Section 2(14) of the IT Act, any asset, including property, is taxable. However, only the profit earned from reselling is taxable instead of the whole amount. On the other hand, if an owner sells a property for genuine purposes like acquiring a new house, Section 54 provides relief from capital gain tax.

What is a Capital Asset?

According to Section 2 (14) of the Income Tax Act, capital assets include any property a person can own and transfer, including real estate, stocks, jewels, buildings, machinery, land, trademarks, patents, automobiles, equipment, leasehold rights, etc. Anything someone owns for a reason, including moveable, immovable, intangible, and physical things, comes under the capital asset category. It can be for any purpose, including personal and professional usage.

Types of Capital Assets Under the Income Tax Act

The Income Tax Act divides capital assets into two main categories for Section 54 capital gain according to the length of their ownership. Here are their brief descriptions:

Short-Term Capital Assets: Short-term capital assets have a short holding period of up to 36 months. This period can be 24 months for immovable properties like land, homes, or buildings and 12 months for equity-oriented mutual funds, zero-coupon bonds, etc.
Long-Term Capital Assets: Long-term capital assets include ones the owners hold for more than 36 months before reselling. A property becomes a long-term capital asset for real estate if the buyer has it for over 12 months. However, the 12-month holding period does not apply to security, mutual funds, and equity shares. They come under long-term assets if the buyer holds them for over 24 months before reselling.

Eligibility Criteria for Availing Benefits Under Section 54

According to the Section 54 guidelines, individuals selling a residential property and using the sale amount for buying another residential property can claim a tax deduction under Section 54. To avail of the benefits, one must fulfil the following conditions:

Only Hindu Undivided Families (HUFs) and individuals are eligible for deductions under Section 54 of capital gain. Companies cannot claim tax benefits under this Section.
The residential property being sold should be a long-term capital asset, meaning the owner should have held it for the minimum period.
The property being sold should be a residential property. Any income earned from it is charged under the income head.
The seller should buy a new residential property within one year of the transfer date or two years of the sale date. In case of a new house construction, the seller can extend the period up to three years from the sale or transfer date.
The new property should be located in India.

What is a Capital Gains Account Scheme?

Suppose the seller does not construct or purchase a new residential property within a year of transfer. In that case, they can still save tax by investing the unutilised capital gain from the sold property in the Capital Gains Account Scheme. Therefore, the scheme allows the seller to purchase a new property later without tax implications.

According to the Income Tax Act, one must fulfil the following conditions for depositing funds in the Capital Gains Account Scheme:

The deposit facility under the scheme is available in approved and authorised bank branches only, excluding bank branches.
The taxpayer should deposit the money before the due date for ITR filing.
According to the legal provisions, the taxpayer must utilise the deposited funds for purchasing or constructing a new residential property only.
The assessee must withdraw the scheme funds to purchase or construct a new house within 3 years of the transfer date. Failure to do so will make the capital gains amount taxable.

What are the differences between Section 54 and Section 54F of the Income Tax Act?

Sections 54 and 54F are the major sections providing capital gain tax exemptions. Let’s understand the difference between the two.

Parameters	Section 54	Section 54F
Applicability	Provides exemptions on long-term capital gains for residential property sales	Provides exemptions on long-term capital gains for assets other than residential properties
Extent	Provides full exemption on the entire capital gain investment	Provides full exemption on the investment of the entire net sale proceeds
Tax Implication	If the taxpayer does not invest the entire capital gain amount, the leftover amount becomes taxable.	If the taxpayer does not invest the entire amount of net sale proceeds, the exemption will be the cost of the new house x Capital Gains/Net Sale Proceeds.

FAQs About Section 54 of the Income Tax Act

Can I claim a capital gains exemption under Section 54 on selling multiple properties?

Exemption under Section 54 is available on the sale of multiple properties only if the seller uses the total sale amount to buy a single residential house.

When can a taxpayer claim exemption under Section 54?

A taxpayer can claim an exemption under Section 54 of the Income Tax Act when they sell a residential property and use the sale amount to purchase another residential house.