The asset sold is a residential house property

The asset sold is a long-term capital asset

The asset purchased should be a residential house property

The purchase should be made within a period of one year before or two years after the date of transfer of the old house property, the taxpayer should acquire or build a property within a period of three years from the date of transfer of the old house

The property purchased/constructed should be in India

The exemption under Section 54 can be claimed only for one residential house property purchased/constructed. However, Section 54 has been amended, w.e.f 1 April 2020 and the benefit of exemption is available in respect of investment made in two residential house properties if the amount of long-term capital gains does not exceed ₹2 crore. This option can be exercised only once by an assessee during his/her lifetime.

For example, Nitin owned residential house A for 10 years. He bought a new residential house B on 1 February 2020 worth ₹1 crore. Nitin sold house A on 2 January 2021 for ₹10 crore. The capital gains (CG) arising on this sale was ₹2 crore. On 1 March, 2022 Nitin purchased house C worth ₹1 crore. He believes that exemption can be claimed in respect of capital gains arising on the transfer of house A since houses B and C have been purchased within the time frame of one year before or two years after. Also, the capital gain is less than ₹2 crore and hence he will be able to exercise the once-in-a-lifetime option of claiming deduction by investing the capital gains in two houses. In this case, his understanding is correct. It is pertinent to note that CG shall be exempt to the extent of CG or amount invested in the purchase/construction of another house, whichever is less.

It is interesting to know what happens if the new residential house property purchased or constructed for claiming deduction under Section 54 is transferred within a period of three years from the date of acquisition. The exemption claimed will be withdrawn. The amount claimed as exempt earlier will be deducted from the cost of acquisition of the new house property.

Suppose, Siddharth held two house properties L, M for the past 8 years. He sold house L for ₹1.75 crore in September 2020 and made a CG of ₹70 lakh. He purchased another house property N in December 2020 for ₹1 crore. He files the ITR in July 2021 and claimed exemption for the entire capital, i.e. ₹70 lakh.

Now, in August 2021, he sold house N for ₹1.05 crore. Thus, the CG will be ₹5 lakh. He does not have any other income during the year. He believes that he will not be liable to pay any tax due to rebate under Section 87A. This belief of Siddharth is not correct; he sold the house property before the completion of 3 years and had claimed Section 54 exemption to the tune of ₹70 lakh. Hence, for the purpose of computation of short-term capital gains, the earlier exemption of ₹70 lakh will be deducted from the cost of acquisition of ₹1 crore. The cost of acquisition for income tax purpose will be ₹30 lakh ( ₹1 crore less ₹70 lakh). The short-term capital gains will be ₹75 lakh ( sale value of ₹1.05 crore less new computed cost of acquisition ₹30 lakh).

Suppose, Rahul sold house property A in July for ₹10 crore and earned long-term capital gains of ₹4 crore. House B is purchased for ₹5 crore in August in his spouse’s name. Can he claim exemption under Section 54? In a recent ruling, Bhagwan Swroop Pathak vs ITO, the Delhi bench of the Income Tax Appellate Tribunal and CIT(A) vs Kamal Vahal 351 ITR 4, the Delhi high court has held that an individual shall be eligible for CG exemption if he invests the entire LTCG towards the investment in another property in the name of the spouse or other relative.