Section 54 of the Income Tax Act: Capital Gains Exemption

Section 54 of the Income Tax Act: Capital Gains Exemption. Investing in real estate is a preferred option for many individuals, especially those who seek a secure and appreciating investment. While property investments can bring substantial returns, they also lead to significant tax liabilities in the form of capital gains. To offer relief from such tax burdens, the Income Tax Act, 1961, has introduced various provisions and exemptions. Among them, Section 54 of the Income Tax Act is an important relief available for taxpayers. This article provides a detailed explanation of Section 54 of the Income Tax Act, focusing on the Capital Gains Exemption it offers, its eligibility criteria, calculation methods, and other essential aspects.
What is Section 54 of the Income Tax Act, 1961?
Section 54 of the Income Tax Act provides an exemption on long-term capital gains that arise from the sale of a residential property. If the gains are reinvested into purchasing or constructing another residential house within a specified time, the seller can claim an exemption from capital gains tax. This section is designed to promote the reinvestment of capital into housing, thereby encouraging the real estate sector and offering tax relief to individuals and Hindu Undivided Families (HUFs).
The exemption is applicable only when the property sold is a long-term capital asset, meaning it has been held for more than 24 months.
What are the Different Types of Capital Assets Under Income Tax?
Capital assets under the Income Tax Act are categorized based on their holding periods. These are classified as short-term capital assets and long-term capital assets.
Short-term capital assets
It refer to assets held for 24 months or less in case of immovable property. If such assets are sold, any gain is classified as short-term capital gain (STCG) and taxed as per applicable slab rates.
Long-term capital assets
on the other hand, are assets held for more than 24 months. Gains arising from their sale are classified as long-term capital gains (LTCG), which attract a lower tax rate. For listed shares, equity mutual funds, and zero-coupon bonds, the period is 12 months instead of 24 months.
In the context of Section 54 of the Income Tax Act, the sold asset must be a long-term residential property to be eligible for the capital gains exemption.
LTCG and STCG Rates in 2023-24 and 2024-25 – Comparison
With the Budget 2024 introducing certain changes, the holding periods and applicable tax rates have been updated for mutual funds. However, for immovable property, the holding period continues to be 24 months to qualify as a long-term capital asset.
The updated capital gain tax rates for mutual fund investments are as follows:

For equity-oriented mutual funds, LTCG is now taxed at 12.5% if held for more than 12 months, while STCG is taxed at 20%.

Debt mutual funds, equity fund of funds (FoFs), and gold mutual funds now attract LTCG at 12.5% when held for more than 24 months. Short-term gains are taxed at slab rates.

Although these changes primarily affect mutual fund investments, they also reflect a shift in tax policy to streamline capital gains taxation across different asset classes.
Who is Eligible to Avail of the Exemption Under Section 54?
The benefit of Capital Gains Exemption under Section 54 of the Income Tax Act is available only to specific categories of taxpayers. This exemption is not open to all types of entities.
Only individuals and Hindu Undivided Families (HUFs) are eligible to claim exemption under Section 54. Companies (Private Limited Company, Public Limited Company, One Person Company), Partnership Firms, or LLPs cannot claim this benefit.
To be eligible, the taxpayer must sell a residential house property, and the income from this property must be chargeable under the head 'Income from House Property'. The sold asset must be a long-term capital asset, i.e., held for more than 24 months.
Also, the exemption is allowed only if the taxpayer invests the capital gains in one residential property in India. Investment in foreign property does not qualify for exemption under Section 54.
Requirements for Claiming Section 54 Exemption
Certain important conditions must be fulfilled to avail of the capital gains exemption under Section 54 of the Income Tax Act:

Purchase of New Property: The taxpayer must purchase a new residential house either within one year before the date of transfer or within two years after the date of transfer of the original asset.

Construction of New Property: Alternatively, the taxpayer can construct a new residential house within three years from the date of transfer.

Investment in India: The new property must be located within India. Any investment in a residential house located outside India will not qualify.

Single Property Condition: The exemption can be claimed only for one residential house property. However, the Finance Act 2019 had provided a one-time benefit of claiming exemption for investment in two properties, subject to capital gains not exceeding Rs. 2 crore.

Use of Capital Gains Account Scheme (CGAS): If the capital gains amount is not fully utilized before the due date of filing income tax return, the unutilized amount must be deposited in the Capital Gains Account Scheme (CGAS) to claim the exemption.

How to Calculate Capital Gain Exemption Available Under Section 54?
The amount of exemption under Section 54 of the Income Tax Act is calculated based on the reinvestment made by the taxpayer in a new residential property.
If the amount of capital gains is less than or equal to the cost of the new residential property, then the entire capital gain is exempt from tax.
If the capital gain is more than the cost of the new residential property, then the exemption is limited to the amount invested in the new house. The remaining capital gain will be taxed as per applicable LTCG rates.
Provisions for Transfer of Property Under Section 54
Under the Income Tax Act, the 'transfer' of a capital asset includes sale, exchange, relinquishment, compulsory acquisition, or conversion into stock-in-trade. Once the property is transferred, the capital gain arises and becomes liable for taxation.
To claim the exemption under Section 54, the investment in the new property must be made within the timelines as mentioned above — either before or after the transfer.
What is a Capital Gains Account Scheme?
The Capital Gains Account Scheme (CGAS) allows taxpayers to park their unutilized capital gains in a dedicated account, so they can still claim exemption under Section 54.
This scheme is helpful if the taxpayer is unable to purchase or construct a new property before the due date for filing ITR. The deposited amount can be used only for the purpose of buying or constructing a house.
There are two types of accounts under CGAS:

Type A (Savings account) – Suitable for short-term deposits

Type B (Term deposit) – Suitable for long-term investment

If the deposited amount is not used within the prescribed period, the unused balance becomes taxable as long-term capital gains in the year in which the period expires.
What are the Consequences of Transferring the New House Property Within 3 Years?
To maintain the benefits of Section 54 exemption, the taxpayer must not sell or transfer the new house within 3 years from its acquisition or construction.
If the property is transferred within 3 years, then the capital gains exemption granted earlier is withdrawn. The amount of exemption will be added back to the capital gains of the year in which the property is sold and taxed as short-term capital gains.
This provision ensures that the exemption is granted only to those who genuinely intend to reinvest in residential housing.
Impact of the Finance Act 2023 on Section 54
The Finance Act 2023 introduced a cap on the maximum exemption that can be claimed under Section 54 and 54F.
As per the new amendment, the maximum deduction allowed under Section 54 is Rs. 10 crore. Any investment above this threshold will not qualify for additional exemption.
This amendment was made to prevent misuse of the provision by high-net-worth individuals who were availing large-scale exemptions by investing in luxury properties.
Tax Implications of Reinvesting the Leftover Amount Under Section 54EC
If the taxpayer is unable to utilize the capital gains fully by investing in residential property under Section 54, he or she may consider investing the balance amount in specified bonds under Section 54EC.
These bonds include those issued by NHAI and REC, which have a lock-in period of 5 years. The maximum amount that can be invested in these bonds is Rs. 50 lakhs in a financial year.
This allows taxpayers to save additional tax by distributing their reinvestments between residential property and capital gain bonds.
What are the circumstances in which Exemption under Section 54 can be withdrawn?
The exemption under Section 54 can be withdrawn under the following conditions:

Sale of New Property within 3 Years: If the new property is sold before completing 3 years, the exemption is revoked.

Non-Utilization of CGAS Funds: If the amount deposited in CGAS is not used within the specified time for purchase or construction, it is treated as LTCG and becomes taxable.

Investment in Property Outside India: If the reinvestment is made in a property outside India, the exemption is denied.

Non-Compliance with Timelines: If the taxpayer fails to meet the investment deadlines (1 year before or 2/3 years after the sale), the exemption is not allowed.

What is the difference between Section 54 and Section 54F?
While both sections offer capital gains exemptions, there are differences:

Section 54 applies when a residential house is sold and the proceeds are used to buy another residential house.

Section 54F applies when any asset other than a residential house is sold, and the proceeds are reinvested into a residential house.

Moreover, in Section 54, the exemption is calculated on the capital gains, while in Section 54F, it is on the entire sale consideration.
Budget 2025 Updates
As per the Union Budget 2025, the rebate under Section 87A has been raised to Rs. 60,000, making incomes up to Rs. 12 lakhs tax-free under the new regime.
However, it is important to note that this increased rebate does not apply to capital gains income, meaning gains from the sale of assets like property or shares will still be taxed, even if the total income is under Rs. 12 lakhs.
Need any Support? Book a Consultation with Compliance Calendar LLP expert through email at info@ccoffice.in or Call/Whatsapp at +91 9988424211.
FAQs on Section 54 of Income Tax Act
Q1. Can I invest in two residential properties and claim Section 54 exemption? 
Ans. Only one property is allowed under Section 54. However, for capital gains not exceeding Rs. 2 crore, a one-time option to invest in two properties is permitted.
Q2. Is the exemption available if I purchase the property outside India? 
Ans. No. The property must be located within India to claim exemption under Section 54.
Q3. Can a company or firm claim the exemption under Section 54? 
Ans. No. Only individuals and HUFs are eligible to claim the benefit of this section.
Q4. What happens if I don’t use the entire capital gain? 
Ans. The unutilized portion can be deposited in the Capital Gains Account Scheme (CGAS) to claim exemption.
Q5. Is it compulsory to construct the house within 3 years? 
Ans. Yes. If opting for construction, the house must be completed within 3 years from the date of sale of the original property.
Q6. What is the maximum deduction allowed under Section 54? 
Ans. As per Finance Act 2023, the maximum deduction is capped at Rs. 10 crore.
Q7. Can the exemption under Section 54 be withdrawn later? 
Ans. Yes, if the new property is transferred within 3 years or conditions are not fulfilled, the exemption gets withdrawn.

Investing in real estate is a preferred option for many individuals, especially those who seek a secure and appreciating investment. While property investments can bring substantial returns, they also lead to significant tax liabilities in the form of capital gains. To offer relief from such tax burdens, the Income Tax Act, 1961, has introduced various provisions and exemptions. Among them, Section 54 of the Income Tax Act is an important relief available for taxpayers. This article provides a detailed explanation of Section 54 of the Income Tax Act, focusing on the Capital Gains Exemption it offers, its eligibility criteria, calculation methods, and other essential aspects.

What is Section 54 of the Income Tax Act, 1961?

Section 54 of the Income Tax Act provides an exemption on long-term capital gains that arise from the sale of a residential property. If the gains are reinvested into purchasing or constructing another residential house within a specified time, the seller can claim an exemption from capital gains tax. This section is designed to promote the reinvestment of capital into housing, thereby encouraging the real estate sector and offering tax relief to individuals and Hindu Undivided Families (HUFs).

The exemption is applicable only when the property sold is a long-term capital asset, meaning it has been held for more than 24 months.

What are the Different Types of Capital Assets Under Income Tax?

Capital assets under the Income Tax Act are categorized based on their holding periods. These are classified as short-term capital assets and long-term capital assets.

Short-term capital assets

It refer to assets held for 24 months or less in case of immovable property. If such assets are sold, any gain is classified as short-term capital gain (STCG) and taxed as per applicable slab rates.

Long-term capital assets

on the other hand, are assets held for more than 24 months. Gains arising from their sale are classified as long-term capital gains (LTCG), which attract a lower tax rate. For listed shares, equity mutual funds, and zero-coupon bonds, the period is 12 months instead of 24 months.

In the context of Section 54 of the Income Tax Act, the sold asset must be a long-term residential property to be eligible for the capital gains exemption.

LTCG and STCG Rates in 2023-24 and 2024-25 – Comparison

With the Budget 2024 introducing certain changes, the holding periods and applicable tax rates have been updated for mutual funds. However, for immovable property, the holding period continues to be 24 months to qualify as a long-term capital asset.

The updated capital gain tax rates for mutual fund investments are as follows:

For equity-oriented mutual funds, LTCG is now taxed at 12.5% if held for more than 12 months, while STCG is taxed at 20%.
Debt mutual funds, equity fund of funds (FoFs), and gold mutual funds now attract LTCG at 12.5% when held for more than 24 months. Short-term gains are taxed at slab rates.

Although these changes primarily affect mutual fund investments, they also reflect a shift in tax policy to streamline capital gains taxation across different asset classes.

Who is Eligible to Avail of the Exemption Under Section 54?

The benefit of Capital Gains Exemption under Section 54 of the Income Tax Act is available only to specific categories of taxpayers. This exemption is not open to all types of entities.

Only individuals and Hindu Undivided Families (HUFs) are eligible to claim exemption under Section 54. Companies (Private Limited Company, Public Limited Company, One Person Company), Partnership Firms, or LLPs cannot claim this benefit.

To be eligible, the taxpayer must sell a residential house property, and the income from this property must be chargeable under the head 'Income from House Property'. The sold asset must be a long-term capital asset, i.e., held for more than 24 months.

Also, the exemption is allowed only if the taxpayer invests the capital gains in one residential property in India. Investment in foreign property does not qualify for exemption under Section 54.

Requirements for Claiming Section 54 Exemption

Certain important conditions must be fulfilled to avail of the capital gains exemption under Section 54 of the Income Tax Act:

Purchase of New Property: The taxpayer must purchase a new residential house either within one year before the date of transfer or within two years after the date of transfer of the original asset.
Construction of New Property: Alternatively, the taxpayer can construct a new residential house within three years from the date of transfer.
Investment in India: The new property must be located within India. Any investment in a residential house located outside India will not qualify.
Single Property Condition: The exemption can be claimed only for one residential house property. However, the Finance Act 2019 had provided a one-time benefit of claiming exemption for investment in two properties, subject to capital gains not exceeding Rs. 2 crore.
Use of Capital Gains Account Scheme (CGAS): If the capital gains amount is not fully utilized before the due date of filing income tax return, the unutilized amount must be deposited in the Capital Gains Account Scheme (CGAS) to claim the exemption.

How to Calculate Capital Gain Exemption Available Under Section 54?

The amount of exemption under Section 54 of the Income Tax Act is calculated based on the reinvestment made by the taxpayer in a new residential property.

If the amount of capital gains is less than or equal to the cost of the new residential property, then the entire capital gain is exempt from tax.

If the capital gain is more than the cost of the new residential property, then the exemption is limited to the amount invested in the new house. The remaining capital gain will be taxed as per applicable LTCG rates.

Provisions for Transfer of Property Under Section 54

Under the Income Tax Act, the 'transfer' of a capital asset includes sale, exchange, relinquishment, compulsory acquisition, or conversion into stock-in-trade. Once the property is transferred, the capital gain arises and becomes liable for taxation.

To claim the exemption under Section 54, the investment in the new property must be made within the timelines as mentioned above — either before or after the transfer.

What is a Capital Gains Account Scheme?

The Capital Gains Account Scheme (CGAS) allows taxpayers to park their unutilized capital gains in a dedicated account, so they can still claim exemption under Section 54.

This scheme is helpful if the taxpayer is unable to purchase or construct a new property before the due date for filing ITR. The deposited amount can be used only for the purpose of buying or constructing a house.

There are two types of accounts under CGAS:

Type A (Savings account) – Suitable for short-term deposits
Type B (Term deposit) – Suitable for long-term investment

If the deposited amount is not used within the prescribed period, the unused balance becomes taxable as long-term capital gains in the year in which the period expires.

What are the Consequences of Transferring the New House Property Within 3 Years?

To maintain the benefits of Section 54 exemption, the taxpayer must not sell or transfer the new house within 3 years from its acquisition or construction.

If the property is transferred within 3 years, then the capital gains exemption granted earlier is withdrawn. The amount of exemption will be added back to the capital gains of the year in which the property is sold and taxed as short-term capital gains.

This provision ensures that the exemption is granted only to those who genuinely intend to reinvest in residential housing.

Impact of the Finance Act 2023 on Section 54

The Finance Act 2023 introduced a cap on the maximum exemption that can be claimed under Section 54 and 54F.

As per the new amendment, the maximum deduction allowed under Section 54 is Rs. 10 crore. Any investment above this threshold will not qualify for additional exemption.

This amendment was made to prevent misuse of the provision by high-net-worth individuals who were availing large-scale exemptions by investing in luxury properties.

Tax Implications of Reinvesting the Leftover Amount Under Section 54EC

If the taxpayer is unable to utilize the capital gains fully by investing in residential property under Section 54, he or she may consider investing the balance amount in specified bonds under Section 54EC.

These bonds include those issued by NHAI and REC, which have a lock-in period of 5 years. The maximum amount that can be invested in these bonds is Rs. 50 lakhs in a financial year.

This allows taxpayers to save additional tax by distributing their reinvestments between residential property and capital gain bonds.

What are the circumstances in which Exemption under Section 54 can be withdrawn?

The exemption under Section 54 can be withdrawn under the following conditions:

Sale of New Property within 3 Years: If the new property is sold before completing 3 years, the exemption is revoked.
Non-Utilization of CGAS Funds: If the amount deposited in CGAS is not used within the specified time for purchase or construction, it is treated as LTCG and becomes taxable.
Investment in Property Outside India: If the reinvestment is made in a property outside India, the exemption is denied.
Non-Compliance with Timelines: If the taxpayer fails to meet the investment deadlines (1 year before or 2/3 years after the sale), the exemption is not allowed.

What is the difference between Section 54 and Section 54F?

While both sections offer capital gains exemptions, there are differences:

Section 54 applies when a residential house is sold and the proceeds are used to buy another residential house.
Section 54F applies when any asset other than a residential house is sold, and the proceeds are reinvested into a residential house.

Moreover, in Section 54, the exemption is calculated on the capital gains, while in Section 54F, it is on the entire sale consideration.

Budget 2025 Updates

As per the Union Budget 2025, the rebate under Section 87A has been raised to Rs. 60,000, making incomes up to Rs. 12 lakhs tax-free under the new regime.

However, it is important to note that this increased rebate does not apply to capital gains income, meaning gains from the sale of assets like property or shares will still be taxed, even if the total income is under Rs. 12 lakhs.

Need any Support? Book a Consultation with Compliance Calendar LLP expert through email at info@ccoffice.in or Call/Whatsapp at +91 9988424211.

FAQs on Section 54 of Income Tax Act

Q1. Can I invest in two residential properties and claim Section 54 exemption?

Ans. Only one property is allowed under Section 54. However, for capital gains not exceeding Rs. 2 crore, a one-time option to invest in two properties is permitted.

Q2. Is the exemption available if I purchase the property outside India?

Ans. No. The property must be located within India to claim exemption under Section 54.

Q3. Can a company or firm claim the exemption under Section 54?

Ans. No. Only individuals and HUFs are eligible to claim the benefit of this section.

Q4. What happens if I don’t use the entire capital gain?

Ans. The unutilized portion can be deposited in the Capital Gains Account Scheme (CGAS) to claim exemption.

Q5. Is it compulsory to construct the house within 3 years?

Ans. Yes. If opting for construction, the house must be completed within 3 years from the date of sale of the original property.

Q6. What is the maximum deduction allowed under Section 54?

Ans. As per Finance Act 2023, the maximum deduction is capped at Rs. 10 crore.

Q7. Can the exemption under Section 54 be withdrawn later?

Ans. Yes, if the new property is transferred within 3 years or conditions are not fulfilled, the exemption gets withdrawn.