Can someone who sells two residential properties to buy a bigger house claim exemption from payment of capital gains tax? The Mumbai bench of the Income Tax Appellate Tribunal (ITAT) recently replied in the affirmative and that too while dismissing an appeal filed by the Revenue (Tax Department) in the ACIT-23(3) vs. Shri Sabir Mazhar Ali case. What does the judgement mean for taxpayers?
The main issue that came up for adjudication before the ITAT was if an assessee who sells two properties and invests the consideration into one residential house is entitled to exemption under Section 54 of the Income Tax Act, 1961 or not. Section 54 provides exemption to individuals and Hindu Undivided Families (HUFs) from capital gains tax on sale of a house provided the proceeds are invested in a new residential unit, within the stipulated time.
The essential conditions for availing the tax benefit under Section 54 are: the person claiming the benefit should be an individual or a HUF; and the residential property being sold should have been in possession of the seller for more than two years. The capital gains can be set off against the purchase of any residential property in the last one year before the sale of the house; or, the seller must buy a residential house from the sale proceeds within two years of the date of transfer of the old house or construct a new house within three years.
If an individual sells one house property to buy another residence, there are no issues. However, the law was unclear on whether a person can sell two houses and re-invest the amount in one residential house and still claim exemption from capital gains tax.
Initially, the Assessing Officer in the case mentioned above decided that the assessee was not entitled to the capital gains tax benefit under Section 54 of the income tax Act, as he had sold two properties and invested the proceeds in one property.
However, the Commission Income Tax (Appeals), on an appeal, decided the case in favour of the assessee. The decision of the CIT(A) was challenged by the Tax Department before the Mumbai bench of the ITAT.
The appellate tribunal upheld the decision of the CIT(A), stressing that, "the Section nowhere restricts the claim of the assessee that he should have sold only one property and claimed exemption u/s.54 of the Act for one property...It nowhere prohibited the assessee to sell more than one residential house."
“Exemption under section 54 has always been a matter inducing litigation; however, the judiciary has time and again adjudged in favour of taxpayers, who were legitimately entitled to the benefit accorded to them by law. In this case too, relief has been granted to the taxpayer, to which she was lawfully entitled,” says Neha Malhotra, Director, Nangia Andersen LLP.
Finance Act 2019
The Finance Act, 2019 amended Section 54 to extend the benefit of exemption in respect of investment made in two residential house properties with effect from Assessment Year 2020-21. In other words, Budget 2019 allowed home buyers to claim long-term capital gains tax exemption if they sold one house and reinvested the proceeds in two residential properties.
There are two conditions: The amount of long-term capital gains must not exceed Rs 2 crore. And this benefit can only be availed once in our lifetime.
Going by the ruling of the ITAT and recent changes in the income tax Act, an individual or HUF will get the benefit of Section 54 if she sells more than one residential properties to buy a new house or sells one house to buy two residential properties. “The judgement shall prove to be beneficial to those taxpayers who wish to purchase/construct a bigger residential dwelling by selling one or more houses. The ruling further re-establishes the faith of the taxpayers in the Indian taxation system that a rightful benefit under law shall not be denied to those eligible for the same,” says Malhotra.(The writer is a freelancer)