Exemption on Capital Gains Tax if House Construction is not Completed in 3 Years

There is an option to claim tax exemption for short-term and long-term capital gains if you invest the gains in a new house. The house can be purchased 1 year before sale of your property or 2 years after the sale of your long-term asset.

Capital gains are made when you sell a capital asset – residential or commercial property, plot, or stocks/shares/bonds – at a higher price than what you bought it for. In short, it is the profit you make on a sale of property. This profit, or capital gains, is taxable. The amount of tax depends on whether the property is a short-term capital or a long-term one.

Short-term capital gains are added to the income of the individual and tax applied according to the income tax slab they fall under. Long-term capital gains (LTCG) are taxable at the rate of 20% plus cess and surcharge. However, you can claim exemption from this tax under Sections 54 and 54F if you are investing the capital gains you make on the sale of property or stocks and bonds, in another house. This house can be bought either 1 year before the sale of your property, or within 2 years after your long-term asset is sold.

Under Section 54EC, you can save LTCG tax is you buy notified government bonds with the profit you make on the sale. However, we will only discuss the conditions surrounding Sections 54 and 54F here.

What is the Purpose of Sections 54 and 54F?

The main purpose of allowing exemptions under Sections 54 and 54F is to encourage individuals to construct or buy houses. One of the sub-clauses in both these sections is that if the house bought through capital gains is to be built or is under construction, the construction should be completed within 3 years of making the investment. This is applicable to both a house that you are building on a plot, or a flat that is under construction when you purchase it.

Based on this clause, persons have often lost their capital gains exemption after 3 years and had to pay the LTCG tax to the Income Tax Department because the construction of the house had not been completed even after 3 years.

Relevant Legal Cases

The Income Tax Act is not very clear on what would happen if the construction of the house is not completed in 3 years. But through several court cases, legal precedent has been set through which LTCG tax exemption under Section 54 and 54F can be availed even if the house an individual bought with the capital gains is not completed within 3 years of purchasing it.

Let us look at a few of these cases in brief:

In the case the Commissioner of Income Tax vs. Sardarmal and Shanthilal Kothari, 2008, the respondents Sardarmal and Shanthilal Kothari had invested their long-term capital gains in a residential property and claimed deduction under Section 54F. However, when the Assessing Officer (AO) visited the property 3 years later, the construction of the house had not been completed. Based on this the AO denied benefits under Section 54F to the Kotharis. The case went up to the Income Tax Appellate Tribunal in Chennai, where the judges ruled the case in favour of the Kotharis. The Tribunal Bench said that “…in order to get the benefit under Section 54F, the assessee need not complete the construction of the house and occupy the same. It is enough if the assessee establish that the assessee had invested the entire net consideration within the stipulated period.”

Another case, Rajneet Sandhu vs. DCIT in 2010 in Chandigarh, also faced the same problem and the Tribunal said it was more important that the entire capital gains were invested in the house within 3 years than the fact that the house is not ready to live in. Even in Pradeep Kumar Chowdhry vs. DCIT, the Tribunal ruled that if the money was invested in the building on time, it was not the assessee’s fault if the builders did not complete the construction on time.

Investment in Flat under Self-Financing Scheme of Delhi Development Authority

A circular issued by CBDT (No. 471) in 1986 affirmed that since the Delhi Development Authority (DDA) is taking up construction of the residential building instead of the assessee, the cost of construction will be considered as the cost of the new asset, and even if the amount is paid in instalments, the exemption under Sections 54 and 54F are applicable. Several cases were cleared by the Tribunal on this basis as well.

The cost of an under-construction apartment is likely to be lower than a house ready for possession. A ready-to-occupy comes at premium prices because of higher demand. Under-construction property may come at special prices, and you might also get enough time to arrange finances and documentation.

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