Section 54 Vs Section 54F Of Income-Tax Act, 1961: Know The Key Legal Differences And Common Compliance Mistakes

In India, the buying and selling of properties, lands or other long-term assets is often tied to a tax responsibility that the individual must cater to. In case of selling any long-term asset, the seller is liable to pay a tax on that asset to the government for earning profits on the sale. Sometimes, this taxable amount is a significant amount in cases of property and housing.

In order to provide relief and encourage reinvestment, the Income-tax Act, 1961, offers a few exemptions under Section 54 and Section 54F. Although the provisions are quite similar to each other, they apply in different circumstances and are subject to specific conditions. A clear understanding between the two can help taxpayers save money on exemptions and not face any technical lapses.

The key difference between the two is that Section 54 applies when a long-term held residential house is sold, and the capital gains are reinvested in another residential house. This has no restriction on the number of houses owned.

However, Section 54F applies when any other long-term asset is sold, and the exemption is only provided if the amount is invested in a residential house. The condition in this is that the taxpayer must only own one residential house on the date of sale.

What Qualifies as a Residential House

Since the Income-tax Act, 1961 does not clearly define the key criteria for a house to be defined as a residential house, the reliance remains on judicial interpretations and administrative guidance. In general, a residential house is defined as a house that is intended for and capable of being used for residential purposes. This can include an independent house, flat, apartment, that is habitable and approved for residential use by the authorities.

Saya Mayank Arora, partner, Chambers of Bharat Chugh, a law firm: “While the Income-tax Act, 1961 does not define ‘residential house’, however, courts have consistently held that a residential house means a property intended for human dwelling, and not merely a structure only for sake. Further, a residential house need not be a single unit and can also be deemed as one unit where two or more units are combined together into a residential house. A residential house must be capable of being used as a dwelling, emphasising on use and character of the property and not the municipal nomenclature. If the property is a habitable dwelling meant for residence, it qualifies under both Sections 54 and 54F.”

Limits Of Purchasing Under Each Section

Both sections have timelines that need to be adhered to for reinvestments. The taxpayer may purchase a residential house either within one year before the date of transfer of the original asset or within two years of the date of transfer.

Additionally, if the taxpayer decides to construct a fresh residential house, the construction must be completed within three years from the date of transfer.

These timelines are important and are strictly enforced by authorities. Failure to adhere to these, even if the reason is genuine, can result in denial of the exemption. In order to be considered again, individuals must have strong judicial precedents and evidence to justify the delays. Therefore, careful planning is an essential step in this process.

Says Arora: “Both sections follow identical timelines. For the purchase of a residential house, the timelines are up to one year before the sale, or within two years after the sale, and if one is constructing a house on a plot, then such construction of a residential house must be completed within three years after the sale. Even advance agreements and allotments can satisfy the requirement of these timelines.”

Common Mistakes That Lead to Denial of Exemption

Exemptions under these sections are often denied due to common mistakes that people make.

Under Section 54F, owning more than one residential house on the date of transfer of the original asset tends to disqualify the taxpayer from claiming this exemption. Missing the timelines set by the authorities is the second mistake people make. Third, incorrect calculation of exemption, specially under Section 54F where the net sale is relevant, results in disallowance.

Selling the newly-acquired residential property within three years leads to withdrawal of the exemption and taxation of the earlier gains. Additionally, investing in commercial property or purchasing only land without constructing a residential house does not satisfy the conditions of these sections.

Adds Arora: “While Sections 54 and 54F are beneficial provisions meant to promote reinvestment in housing assets, courts have repeatedly made it clear that these exemptions are available only when statutory conditions are strictly followed by the taxpayers.”

These sections allow taxpayers to provide valuable and legitimate opportunities to save on long-term capital gains (LTCG) arising from the sale of their assets. However, these benefits are conditional upon strict compliance with the law and the rules set by the statutory authorities. Given the complexity and the significant tax implications involved, careful planning and professional advice can help taxpayers maximise benefits, while remaining fully compliant with the law.