The Indian taxation system incorporates a complex framework with the primary objective of ensuring the government’s revenue collection for effective functioning. Long-term capital gains tax has consistently been a concern for taxpayers, particularly those involved in the sale of immovable properties such as land or buildings.
To overcome tax liabilities and promote investment in the real estate sector, the Income Tax Act introduced Section 54 and Section 54F. This provision alleviates the tax burden on individuals’ gains from selling a property, listed/unlisted shares etc., fostering economic growth. In the realm of investments and financial planning, understanding the intricacies of long-term capital gains and their taxation is paramount.
The impact of Section 54 and Section 54F on real estate is twofold. This includes (1) a notable surge in investments in the real estate sector and (2) a substantial upswing in the supply of residential properties.
Breaking down Section 54 and Section 54F:
Maximising gains through reinvestment
When you sell your residential property and earn a profit, you must pay capital gains tax on the sale’s profits. However, to save on taxes, you can take advantage of Section 54, which grants an exemption on long term capital gain on sale of residential property, if you reinvest the said gains in a new residential property in India.
In the same way, Section 54F provides tax exemption on long-term capital gains arising from the sale of any long-term capital asset (other than a residential house) like equities (listed & unlisted both), jewellery, bonds, etc. if the net consideration (including the long-term capital gain) is reinvested in a residential house in India.
To claim Section 54 and Section 54F exemption, taxpayers must meet the following conditions:
a. The purchase of a new residential property must occur within one year before the date of transfer or within two years after the date of transfer.
b. If you choose to construct a new residential property, it must be completed within three years from the date of transfer.
c. It is imperative to hold the newly acquired residential property for a minimum period of three years.
Section 54 and Section 54F exemptions are available to two categories of taxpayers:
1. Individuals
2. Hindu Undivided Families (HUFs)
In a decisive move, the Budget 2023 has established the exemption limit for Section 54 and Section 54F at an impressive Rs 10 crore. This significant adjustment has been implemented with several key objectives in mind, ensuring a robust tax system and a well-functioning real estate market.
Difference Between Section 54 and 54F
Section 54 and Section 54F of the Income Tax Act, 1961 are two distinct provisions that provide tax benefits for different types of capital gains. While they both aim to encourage investment and economic growth, it is important to note that these sections operate independently of each other.
Exemption under Section 54 is available on long-term capital gain on sale of a house or residential property. While exemption under Section 54F is available on long-term capital gain on sale of any asset (other than a house property) like equities (listed & unlisted both), jewellery, bonds, commercial property etc.
Under Section 54, in order to avail exemption, the profits (capital gains) obtained from the sale of a property must be invested. If the entire (profits) capital gains are not invested, the remaining amount is subject to tax as long-term capital gains.
Furthermore, if the newly purchased property is sold within three years of its acquisition, the benefit granted under Section 54 is withdrawn.
Section 54F on the other hand provides for a proportional exemption based on the investment made. To qualify for the tax exemption, the entire amount received from selling the original asset must be invested (cost of purchase + profit). If the entire sale proceeds are not invested, the exemption is granted proportionately.
Further, in Section 54, there is no limit on number of residential houses you own on the date of transfer of residential house property whose capital gain tax is required to be claimed as exemption. However, in Section 54F, exemption is not available in case the transferor holds more than one residential house property on the date of transfer.
Section 54 and 54F: a catalyst for investment and economic growth
Section 54 and Section 54F aim to incentivise individuals by offering tax relief and exemptions on capital gains arising from the sale of residential property and other long-term capital assets respectively. The central idea behind this section is to encourage investment in productive assets, thereby fostering economic growth through increased capital formation.
Section 54 and Section 54F drive investment and contribute to economic prosperity as there is heightened demand for residential property. The tax relief empowers individuals to redirect their capital gains toward acquiring residential properties. As a result, the heightened demand for residential property triggers price surges, fuels construction activities, and sets a ripple effect in real estate allied services.
Section 54 and 54F: empowering financial planning strategies
a. Tax saving for enhanced wealth growth: Reinvesting capital gains in a residential property under Section 54F enables individuals to save tax. This deferral provides immediate savings on taxes and allows individuals to allocate more resources toward wealth-building activities.
b. Accelerated wealth building through equity: Individuals effectively acquire a share of that property by reinvesting capital gains in a residential property. As the property appreciates over time, the individual’s equity also increases. Real estate has long stood the test of time and has proven to be the most reliable asset in an investment portfolio.
c. Inflation protection and asset value preservation: Residential property has historically demonstrated the ability to outpace inflation. As property prices rise with inflationary pressures, individuals who have invested their capital gains in residential properties can benefit from the appreciation in value.
It is important to understand tax implications and exemptions that one is liable to while closing real estate transactions as an investor so one can gain maximum ROI from them.
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