The Interim Budget 2019-20 included an amendment of the capital gains rollover benefit offered under Section 54 of the Income Tax Act — this lesser known section of the Income Tax Act, 1961 is designed to help individual real estate investors save on the capital gains tax they would be required to pay in case they sell one residential property for a profit and use the capital gains to purchase a new residential property within a pre-determined time period.
While this benefit is already available, its scope has been expanded to the purchase of two new properties instead of one up to capital gains of Rs 2 crore. In the following sections, we will discuss these changes in detail.
Section 54 benefit for FY 2018-19
In its current form (as of FY 2018-19), Section 54 of the Income Tax Act 1961 stipulates that capital gains obtained from the sale of a residential property will be tax exempt, provided the following conditions are met:
- The gains are invested for the purchase of a new residential property
- The purchase of new residential property occurs within one year prior to the sale or two years subsequent to sale of the real estate asset
- In case the new investment is an under-construction residential property, the construction must be completed within 3 years of the date of transfer of the old property
- The new residential property is held for at least 3 years from the date of purchase.
This benefit is available only to individuals and HUF (Hindu Undivided Family). As of FY 2018-19, this benefit is available only once in the lifetime of the individual and can only be claimed on the purchase of only a single residential property. The amount of tax exemption that can be claimed under section 54 currently is the lower among the following:
- The total amount obtained as capital gains from transfer of residential property, or
- Total investment made in lieu of purchase/construction of the new residential property
Also notable is the fact that both the transferred property and the new residential property must be located in India — foreign real estate investments do not qualify for this benefit.
Revised Section 54 benefit for FY 2019-20
The Interim Budget 2019 amended the capital gains benefit under section 54 in two unique ways. Firstly, the capital gains from the transfer of residential property can now be used to purchase up to two new properties instead of just the one that could be purchased earlier — secondly, the rollover benefit will now be applicable to capital gains of up to Rs. 2 crore.
No changes regarding requirements for availing this benefit were mentioned in the Interim Budget speech.
What are the benefits for real estate investors?
As a result of amendment in capital gains rollover benefit, real estate investors will be able to avail taxation benefits on two new properties bought using capital gains from an old property. Moreover, the amount that can be claimed as an exemption is now Rs 2 crore — which translates into a potential tax liability reduction of up to Rs 40 lakhs in a financial year (calculated without indexation at LTCG rate of 20 per cent on real estate property).
However, this may very well turn out to be a lower limit than earlier — this is because earlier you could potentially claim the benefit on a higher capital gains amount provided you reinvested the entire gains from the sale of your old property into a new residential property.
Quantifying Section 54 benefits
The following is a sample calculation quantifying the Section 54 benefits before and after the amendment announced in Interim Budget 2019.
Let's assume capital gains from sale of old property = Rs 2 crore
Cost of new house 1 (bought less than 2 years after transfer of old property) = Rs. 1.5 crore
Cost of new house 2 (bought less than 2 years after transfer of old property) = Rs. 1.5 crore
Under existing Section 54 rules, taxable capital gains from sale = Rs 50 lakhs (2 crore -1.5 crore = 50 lakhs) as benefit is available on one new residential property only. Tax liability at 20 per cent of taxable gains = Rs 10 lakh (without indexation benefit).
Under new Section 54 rules, the entire Rs 2 crore of gains from sale of old property will be completely exempt from tax as the cost of purchasing the new houses is Rs 3 crore (1.5 crore + 1.5 crore = 3 crore) that exceeds the total gains from old property at Rs 2 crore.
In the above case, the amended rules are better for the individual investor.
Following is another example of how the amended rules can impact tax liability:
Let's assume the following:
Capital Gains from sale of old property = Rs 3 crore
Cost of new house bought within 2 years of sale = Rs 3 crore
In this case:
Taxable capital gains under old Section 54 rule (FY 2018-19) = Nil (3 crore - 3 crore = 0)
Taxable capital gains under new Section 54 rule (FY 2019-20) = Rs 1 crore (3 crore - 2 crore = Rs 1 crore ) i.e. tax payable on gains = Rs. 20 lakhs (before indexation benefit). This is because the new rules limit capital gains rollover benefit to Rs 2 crore.
Thus, from the point of view of capital gains benefit limits, the earlier regime was better.
Real estate investments have typically been favoured by high net worth individuals and the new rules of capital gains roll over might definitely lead more people to invest in multiple residential properties. However, this benefit is still a once in a lifetime deal — and the new properties will have to be held for at least 3 years to avail the benefit.
Thus, the benefit provided by Section 54 is definitely limited for short-term investing, even after the expanded rules come into effect.
Perhaps even more importantly, big ticket luxury property sales might only witness limited growth from the amendment. This is due to the cap of Rs 2 crore whereas it is basically unlimited if the new property price exceeds total capital gains. That said, buying multiple properties in the mid-range segment is a definite possibility now that the capital gains rollover benefit has been extended to two residential properties instead of just one.
Thus, medium ticket size property investments by individual real estate investors may increase as a result of the proposed amendments.