Capital Gains Exemption for Residential Property

Income Tax Act provides capital gains exemption for persons who are selling a residential property to purchase another residential property. The reason for selling the property can be on account of shifting the residence. Hence, if a person sells a house and purchases another house from the sale proceeds, then the capital gains are not taxable. In this article, we look at the regulations relating to capital gains exemption for residential property.

Exemption under the Income Tax Act

The Income Tax Act provides relief to a taxpayer who sells a residential house, and from the sale-proceeds acquires another residential house with the intention of shifting the residence. In such a case, the person has entered into a property sale transaction not for earning income through the sale of the old house but to acquire another suitable house. Hence, in such cases, the seller shall be provided exemption on capital gains arising on the sale of the old house.

Eligibility Criteria

To be eligible for the capital gains exemption, the income tax assessee must be an individual or HUF, and not a company or LLP or partnership firm or other types of legal entities. Further, the asset transferred should be a long-term capital asset. To qualify for exemption under the Act, the assessee should have held the asset for at least thirty-six months.
The asset should be a residential house property. Hence, the net annual value calculated for the house should be chargeable to tax under the head, 'Income from House Property'.
Also, within a period of one year before or two years after the date of transfer of the old house, the taxpayer should acquire another residential house or should construct a residential house within a period of three years from the date of transfer of the old house.
Finally, the taxpayer can claim capital gains exemption for only one residential house property purchased or constructed in India. If more than one house is purchased or constructed, in such cases, the exemption will be provided for one house only.
If a person has claimed benefits under the Act during the sale and purchase of a new residential property, then the assessee should be bound by certain restrictions on the sale of the new residential property. If a taxpayer transfers the new house within a period of three years from the date of its acquisition or completion of construction, in such cases, the benefit of exemption granted under the Act shall stand withdrawn.

Amount of Capital Gains Exemption

The amount of capital gains exemption under Section 4 of the Income Tax Act would be the lower of:

Amount of capital gains arising on transfer of residential house; or
Amount invested in the purchase or construction of new residential house property.

Capital Gain Deposit Account Scheme

To claim capital gains exemption, the taxpayer should purchase another house within a period of one year before or two years after the date of transfer of old house or should construct another house within a period of three years from the date of transfer. If, till the date of filing the return of income, the capital gain arising on transfer of the house is not utilized to purchase or construct another house, then the benefit of exemption can be availed by depositing the unutilized amount in Capital Gains Deposit Account Scheme in any nationalized bank. When the amount of taxable capital gains is deposited in the capital gains deposit account scheme, a new house can be purchased or constructed by withdrawing the amount from the account within the specified time-limit of two or three years, while at the same time availing of the capital gains exemption. In case the assessee wishes to make use of the deposit scheme, the assessee should, together with the return of income, submit proof of having made the deposit.

Conditions for Purchase of New Residential Property

For claiming the exemption the specified conditions have to be followed. The specified conditions are the following:
The new house property should be situated in India. Only one residential property can be purchased or constructed. Constructing an apartment with several residential units is allowed.
A single long term capital gain can be invested in two house properties which are used as a single residential amenity. The benefit can be availed even if the properties are purchased using separate sale deeds and are having separate electricity meter connections.
Consideration is deemed to have been settled if a substantial portion of the price of the property has been settled. Hence, an immediate transfer of legal title is not necessary. Thus, the sale deed can be registered after the expiry of the three-year time limit.
The assessee may exchange an old residential property in exchange for a new one. In such cases, the assessee shall be allowed to make use of the benefit of capital gains exemption. However, any purchase of tenancy rights does not confer the right to claim the exemption.
Capital gains arising from the sale of two different residential properties can be combined together for the purpose of making a single investment. The investment is eligible for the exemption under the Act.

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