Reinvesting capital gains for tax breaks

Last Updated: Sun, May 12, 2013 06:19 hrs

Most taxpayers are happy selling their existing homes and investing the same money to buy another one as they are aware that any gains that they make on selling the old property is exempt if it is reinvested in (or used for constructing) another property within the prescribed time limit (as per the provisions of section 54 of the Income Tax Act).

First time home buyers, too, can take benefit of an exemption if they are selling other long-term assets like gold, silver, plot of land, and so on to invest in (or construct) their dream homes (in accordance with the provisions of section 54F of the Act).

In one of the recent cases that came up for decision with the Hyderabad Tax Tribunal, the question that came up for decision was whether a taxpayer can claim exemption from long-term capital gains arising from the sale of a property and an asset other than property by investing in a single residential property?

The taxpayer had earned long-term capital gains from the sale of two distinct and separate assets; one being a plot of land and the other being a house property. He claimed that the entire long-term capital gain arising from the sale of these two capital assets was invested in purchase of the new residential house and, hence, he was entitled to claim exemption under section 54 and 54F of the Income Tax Act. The tax officer, based on his interpretation of these two sections, was of the opinion that for claiming exemption under both the sections, the taxpayer had to invest in two houses. On this basis, he rejected the taxpayer's claim.

The taxpayer appealed against the said order. During the course of the appellate proceedings, the taxpayer contended that section 54 and 54F are independent provisions and not mutually exclusive. He submitted that both the sections require investment in a new house and that neither section 54 or 54F nor any other provisions of the Act restricted the taxpayer from claiming exemption under both the sections against investment in the same residential property.

The appellate authority, however, dismissed the taxpayer's claim and held that while the purpose of both the referred sections is to give fillip to the housing sector, the language of the sections envisage different sources of investment in a residential house. The authority also held that the two sections are meant to operate in an exclusive manner and cannot be clubbed together for getting a bigger advantage of exemption on account of bigger investments.

The taxpayer preferred a second appeal with the Tax Tribunal. At this level, the taxpayer submitted that section 54 and section 54F are independent and operate in isolation. It was submitted that the interpretation of the tax officer and the lower appellate authority that as the two sections are separate and call for investment in one residential house each, is not a correct interpretation. In the current case too, the taxpayer argued that no double deduction was being claimed as the entire capital gain arising out of sale of residential house is invested in the part of the new residential house and the sale consideration received from sale of plot of land is invested in another part of the house.

The honourable Tribunal, in its decision, held that a reading of section 54 and 54F makes it clear that they are independent of each other and operate in respect of long term capital gains arising out of transfer of distinct and separate long-term capital assets. However, both the sections allow exemption only on purchase or construction of a new residential house. In the current case, the taxpayer had sold two distinct and separate long term capital assets, that is, one is a residential house which comes under section 54 and the other is a plot of land, under the ambit of section 54F. The taxpayer has also purchased a residential house within the prescribed period in terms with both section 54 and 54F for a price much more than the long term capital gain.

The Tribunal observed that the only reason for the tax officer and the first appellate authority to reject the taxpayer's exemption claim was that he cannot claim exemption under both the sections towards investment in a single house. The Tribunal did not concur with this interpretation and observed that the same is totally misconceived and misplaced. The restriction imposed under section 54F does not allow exemption if the taxpayer purchases or constructs more than one residential house. In view of the above, the Honourable Tribunal held favourably that the taxpayer is entitled to claim exemption for the amount invested in the new residential house under section 54 as well as section 54F. It also held that there is no specific bar under either of the sections or any other provision of the Act prohibiting allowance of exemption under both the sections in case the conditions of the provisions are fulfilled.

This decision has to be viewed as a favourable interpretation of the capital gain exemption provisions in favour of the taxpayer. In the current scenario, it is quite common for individuals to sell their existing assets and reinvest the same into buying a home for oneself.

With home prices rising high, decisions like the one above help individuals in better tax planning and management.
The writer is a certified financial planner

  • Under Section 54 profit from selling property is exempt from capital gains tax if it is reinvested in another property
  • Under Section 54F profit from selling long-term assets like gold, silver, land is exempt from capital gains tax if it used for construction of a house
  • Taxpayers can claim exemption under both sections for construction of one residential house, says Hyderabad Tribunal

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