Capital Gains Exemption Case Highlights Need For Timely Reinvestment, Not Just Procedural Compliance

In recent news, a person named Krishnamoorthy was initially denied a Rs 10 lakh capital gains tax exemption by the Income Tax Department because he did not deposit unutilised sale proceeds into the Capital Gains Account Scheme (CGAS). He won the case in ITAT Chennai. The court ruled that the reinvestment made within the prescribed three years is what matters, and not the procedure of the CGAS deposit.

Understanding Section 54 

To claim a capital gains exemption under Section 54, taxpayers must follow specific timelines. When a residential property is sold, a new house can be bought within one year before the sale or up to two years after it. Construction timelines are more generous, allowing three years from the sale date for completion.

“Section 54F applies to sales of long-term capital assets other than residential property, maintaining identical timelines. The exemption is proportionate to the amount reinvested relative to total sale proceeds. A key restriction under Section 54F prohibits owning more than one residential house on the transfer date and bars purchasing additional residential properties within one year after sale,” says Vedant Choudhary, associate, SKV Law Offices.

Both sections require the sold asset to be a long-term capital asset (held over 24 months), and the new property must be located in India.

Errors To Avoid 

Several procedural errors frequently result in exemption denial despite eligible transactions. The most common mistake is missing the CGAS deposit deadline when a new property acquisition cannot be completed before ITR filing. 

This oversight can cost taxpayers lakhs in additional tax liability. “Another mistake is selling the new property within three years of purchase or construction, because it triggers an exemption reversal, making the previously exempted gains taxable,” says Choudhary.

Taxpayers must hold the new property for at least three years, whether the exemption is through reinvestment or CGAS. Missing documents like proof of gains, construction certificates, or records of improvement costs can lead to denial of exemption or inflated tax liability.

Capital gains reinvestment should be viewed not merely as a compliance exercise but as a strategic opportunity to optimise one’s real estate portfolio. “By carefully timing the sale and reinvestment, taxpayers can transition out of low-performing assets, upgrade to properties with stronger appreciation potential, better rental yields, or superior location advantages, and thereby convert a one-time capital event into a sustained wealth-building strategy,” says  Alay Razvi, Managing Partner, Accord Juris. 

In essence, the exemption provisions under the law serve not only to defer tax but also to enable smarter capital deployment for long-term value creation.