In an economic climate where investment appreciation is becoming increasingly common, understanding capital gains and how to minimise the associated tax liability is crucial. The taxpayers can claim exemptions under Sections 54 and 54F of the Income Tax Act for capital gains. These provisions offer tax-saving benefits on long-term capital gains, provided these are invested in residential property within a specific timeframe.

Eligibility to claim exemptions under Section 54F

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The key condition to avail of the tax benefits under Section 54F is to reinvest the proceeds from the sale or transfer of an asset in a new residential property. This reinvestment should take place either one year before the sale of the asset or two years (for purchase) or three years (for construction) after the sale. It applies to long-term capital assets, i.e., assets held for more than 24 months, with the exception of real estate, where the holding period is 36 months. This provision can be applied to all capital assets other than residential property, such as gold, equity shares, and non-residential property.

Capital gains tax exemption example 1

You sold a residential property for Rs 80 lakh that you had initially purchased for Rs 30 lakh. This means you made a long-term capital gain of Rs 50 lakh (80 lakh - 30 lakh).

The amount exempted under Section 54 will be the lower of the capital gain or the investment made in the new property. If you purchase a new property for Rs 40 lakh, the amount will be exempted (the cost of the new property), and the remaining Rs 10 lakh (50 lakh - 40 lakh) would be taxable under the applicable capital gains tax rate.

Capital gains tax exemption example 2

You sold gold worth Rs 90 lakh that you initially bought for Rs 20 lakh. The long-term capital gain here is Rs 70 lakh (90 lakh - 20 lakh). According to Section 54F, if you use the entire sale consideration (not just the capital gain) to buy a residential property within the specified time frame, you can claim tax exemption. 

If you are unable to use the proceeds towards reinvestment within the same financial year then the proceeds from the sale must be kept in a Capital Gains Account scheme to claim tax benefits. 

Section 54F in relation to residential property

An important condition for availing the exemption is that the taxpayer should not own more than one residential house other than the new property, at the time of the sale of the original asset. One significant update announced in the Budget 2023-24 was the deduction cap of Rs 10 crore for capital gains on investments in residential properties under Sections 54 and 54F.

Section 54 focuses on long-term capital gains derived from the sale of a residential property. Contrarily, Section 54F caters to long-term capital gains obtained from the sale of any asset other than a residential property. If these gains are reinvested in a new residential property, tax benefits can be claimed. Much like Section 54, the exemption amount is determined by the lower value between the capital gains or the investment made in the new property.

It’s important to note that the exemptions on capital gains tax can be claimed by the individual taxpayer or Hindu undivided family (HUF)

Understanding Capital Gains and Capital Gains Tax

Capital gains refer to the increase in the value of an asset or investment over time, resulting in a profit when the asset is sold. This profit is considered taxable income and is subject to capital gains tax. For example, if you purchase gold for Rs 1 lakh and sell it later for Rs 1.5 lakh the capital gain is Rs 50,000. This amount is subject to capital gains tax.

Currently, the capital gain tax in India is set between 10-20 per cent depending on class of asset and tenure of investment. The different assets that attract capital gains are real estate, stocks and bonds; precious metals and gems; art and collectibles; business assets, investment property; and mutual funds and ETFs.

What is indexation and how to avail its benefit?

Indexation is a technique that takes into account inflation from the time you bought the asset to the time you sell it. It adjusts the purchase price of the investment, which reduces the total taxable capital gain amount.

To avail the benefit of indexation, you need to calculate the indexation factor based on the Consumer Price Index (CPI). The Central government releases these indices each year. The indexed cost of acquisition is calculated as:

Indexed Cost of Acquisition = Cost of Acquisition * (CPI of the year of sale/CPI of the year of purchase)

By increasing the purchase price through indexation, the capital gain decreases, thereby reducing the capital gains tax.