SECTION 54-F OF INCOME TAX ACT

EXEMPTION OF INCOME OF CAPITAL GAIN TAX ON THE SALE OF RESIDENTIAL PROPERTY

Section 54F of the Income Tax Act in India provides provisions for the exemption of capital gains tax on the sale of a residential property. Here are the key points related to Section 54F:

1. Applicability: Section 54F applies to individual and Hindu Undivided Family (HUF) taxpayers.
2. Nature of Asset: It is applicable when an individual or HUF sells any long-term capital asset other than a residential house.
3. Investment in Residential Property: To avail the benefit under Section 54F, the taxpayer is required to invest the capital gains in purchasing or constructing a new residential property. This property should be located in India.
4. Timeframe for Investment: The taxpayer must invest the capital gains amount within a specified time frame. This investment should be made either one year before or two years after the date of the sale of the asset.
5. Conditions for Exemption: The amount of capital gains invested in the new residential property will be exempt from taxation under Section 54F. If the entire capital gains amount is not utilized for the new property, then the exemption will be proportionate.
6. Lock-in Period: The new residential property, in which the capital gains are invested, has a lock-in period of three years from the date of its purchase or construction. The property cannot be transferred or sold within this period. If it is, the exemption will be reversed, and the capital gains will become taxable.
7. Multiple Properties: Section 54F allows the taxpayer to invest in more than one residential property to claim exemption, but the total investment in the new properties should not exceed the capital gains.
8. Other Conditions: The taxpayer should not own more than one residential house, other than the new property, at the time of transfer of the original asset. Also, the taxpayer should not purchase another residential house within one year or construct another residential house within three years of the transfer of the original asset.

It’s important to consult a tax expert or refer to the latest provisions of the Income Tax Act and relevant notifications for the most accurate and up-to-date information, as tax laws are subject to change, and the specific requirements and conditions may vary.

In growing Businesses, one makes money not by profits, but by equity. If you sell a portion of the equity in your Business or your entire Business, if you have been holding your shares for more than 2 years, you incur a Long Term Capital Gain.

If the Long Term Capital gain amount is more than Rs. 5 crores, you incur a total tax of 24%. This is calculated as a 20% base with 4% CESS and a 15% surcharge (0.2 x 1.04 x 1.15).

Now imagine, you just sold your Business for Rs. 100 crores and suddenly you owe Rs. 24 crores to the Government, assuming that you started your business out of nothing. Would you pay it? Is there a way to reduce the tax burden? How?

There is a simple rule called Section 54F of the Income Tax Act. It says that if you incur a Long Term Capital Gain and you invest the Sale proceeds in a Residential Property, the amount that you invest in the Property will be tax-exempt.

This means that if you sell equity in your Business worth Rs. 100 crores and say you invest all of that in a property, you walk away paying ZERO tax. Yes, you heard it right – ZERO tax.

The catch? Only 1 Property per shareholder is allowed. And so, many Business owners put their wives, parents, sons/daughters, etc., on the cap table. This allows one to split the gain of Rs. 100 crores into say 4 people and purchase 4 properties of Rs. 25 crores each (easier!).

Also, a property gives you a rent of 2.5% per year. Net would be around 2% after paying maintenance and other repair expenses. Across a 3-year period, you end up with Rs. 106 crores total including the rent. Include appreciation, and you easily end up at Rs. 115 crores.

If you had not purchased the property, you would be down to Rs. 76 crores after paying tax. From this, if you want to reach Rs. 115 crores over 3 years, you need a CAGR of almost 15%. Which asset class will give you a guaranteed 15% CAGR over a 3-year period?

By the way, I have counted 3 years as the period because you are supposed to not sell the property for 3 years otherwise your tax exemption would be cancelled as per Section 54F.

A lot of Business owners exploited the hell out of this hack and paid no taxes in business/equity sale. So, this year, the Government has put a cap saying that tax exemption would be applicable only for a maximum amount of Rs. 10 crores.

This means that if you sell your Business for Rs. 100 crores, you can buy a property for Rs. 100 crores, but you will get tax exemption only on the first Rs. 10 crores. For the remaining Rs. 90 crores, you have to pay 24% tax.

This is the reason why you hear news of many executives, purchasing luxury properties in South Bombay for several crores, or even tens of crores.

Of course, this is one of the reasons why people purchase such luxury properties. Not everyone purchases them for this reason only. Some might purchase just because they have the money and they like the property. Or for other reasons.

This is perfectly legal and is allowed by the Government. So by no means is it tax evasion. This is a legal method of saving tax, just like Section 80C, 80D, etc.

BTW, this is also applicable when you sell your stocks or Mutual Funds. There is no minimum cap. Let’s say you had invested Rs. 10 lakhs in Equity Mutual Funds some 20 years ago. Now, they are worth Rs. 30 lakhs. Your gain is Rs. 20 lakhs and tax would be ~Rs. 4 lakhs.

You can invest Rs. 30 lakhs in a residential property and not sell it for 3 years and you will not have to pay a penny of this Rs. 4 lakhs worth of tax. In 3 years, if the property appreciates to Rs. 33 lakhs, you can sell it and pay no tax on Rs. 30 lakhs.

The only tax liability would be on the Rs. 3 lakhs of appreciation of the property. That would be ~0 due to the indexation benefit. So overall, you save your Rs. 4 lakhs of tax.

Only 1 property per shareholder is allowed for a maximum of 2 properties. If you already own 2 residential properties in your name, you cannot take the benefit of Section 54F.

A few notes basis the replies:

1. After 3 years, if the person decides to sell the property for Rs. 115 crores, tax has to be paid only on the incremental Rs. 15 crores. The base Rs. 100 crores becomes tax-free.

2. On Rs. 15 crores, indexation is applicable, so tax is ~0

3. The example above is of unlisted equity, so the LTCG Tax is 20% + surcharge. For listed, it is 10% + surcharge.

4. While I have taken an example of Rs. 100 crore, the benefit works for all amounts. Just that, surcharge is low so not attractive enough compared to equity.

5. The benefit is not applicable for Short Term Gains.

6. Only 1 property per transaction per shareholder can be purchased, provided that the shareholder doesn’t already have 2 or more properties in their name.

7. Please consult your CA for proper tax advice for your case.