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Sec 54F: a hack that can save lakhs in taxes when you buy a house


10 Jul 2022 - Contact Sayan Sircar
9 mins read

This article shows how to save capital gains taxes under income tax Section 54F when you sell other assets to raise money to buy your first or second house.

Sec 54F: a hack that can save lakhs in taxes when you buy a house

If you ever decide that you will sell your mutual funds to buy a house you will be in for a pleasant surprise. Section 54F of the income tax act says that long term capital gains, on selling mutual funds for example, are tax free if you use that money to buy a house.

Table of Contents

What is Section 54F?

Introduced in 1983, Section 54F of the Income Tax act, as sourced from the Income Tax website, allows us to save capital gains tax if we sell mutual funds to buy a house.

Insertion of new section 54F.
12. In the Income-tax Act, after section 54E, the following section shall be inserted with effect from the 1st day of April, 1983, namely: —

'54F. Capital gain on transfer of certain. capital assets not to be charged in case of investment in residential house.



The basic premise of this tax exemption is very simple:

  • you wish to buy a house in India as an individual or HUF
  • you sell Mutual funds, shares, gold etc, to buy the house
  • on the date of the MF sale, you do not already own more than one house
  • you don’t have to pay capital gains taxes (only if it is long term gains) on the MF/shares/gold you sold

We will now break down and analyse each subsection of 54F to understand the terms and conditions implied.

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First section: basic terms, timelines and eligibility

The first section as per the act

(explanation follows below)

(1) Where, in the case of an assessee being an individual, the capital gain arises from the transfer of any long-term capital asset, not being a residential house (hereafter in this section referred to as the original asset), and the assessee has, within a period of one year before or after the date on which the transfer took place purchased, or has within a period of three years after that date constructed, a residential house (hereafter in this section referred to as the new asset), the capital gain shall be dealt with in accordance with the following provisions of this section, that is to say,—

(a) if the cost of the new asset is not less than the net consideration in respect of the original asset, the whole of such capital gain shall not be charged under section 45;

(b) if the cost of the new asset is less than the net consideration in respect of the original asset, so much of the capital gain as bears to the whole of the capital gain the same proportion as the cost of the new asset bears to the net consideration, shall not be charged under section 45:

Provided that nothing contained in this sub-section shall apply where the assessee owns on the date of the transfer of the original asset, or purchases, within the period of one year after such date, or constructs, within the period of three years after such date, any residential house, the income from which is chargeable under the head 'Income from house property', other than the new asset.

Explanation.—For the purposes of this section,—

(i) 'long-term capital asset' means a capital asset which is not a short-term capital asset;

(ii) 'net consideration', in relation to the transfer of a capital asset, means the full value of the consideration received or accruing as a result of the transfer of the capital asset as reduced by any expenditure incurred wholly and exclusively in connection with such transfer.



Understanding the first section

  • Original asset: this is the asset sold to buy the house. This can be Mutual funds, shares, gold etc. This cannot be another house which comes under Section 54E
  • Date of sale (DOS): date on which the original asset was sold
  • New asset: the new house that is constructed / purchased. It has to be in India
  • What are the timelines: DOS must be within a year of purchase of the new asset. In case the new asset is being constructed, the construction has to finish within three years of DOS
  • the tax exemption is available only if you already own not more than one house. This rule is thus beneficial if you are buying your first or second house only. It also means that if you have taken the exemption once for your first house, you can take it again for your second house as well
  • the capital gains has to be long term. For equity mutual funds and shares this is one year while for debt mutual funds it is three years.

Related:
How is tax calculated on selling shares/MFs and how do to do tax harvesting?

If your new house costs more the mutual funds you sold, you can save lakhs in capital gains tax

If the cost of the new asset is X and the sale proceeds from original asset sales is Y, then

  • if X ≥ Y, i.e. the new house is at least as expensive compared to the sale, then entire capital gains on original assets sale is tax-free
  • if X < Y, then the capital gains will be exempt in the ratio of Y used to buy X. For example, you sold 20 lakhs of assets and have a capital gains tax of 4 lakhs. The house costs 15 lakhs. The capital gains exempt from tax will be 15/20 * 4 = 3 lakhs. The other 1 lakh of capital gains will be taxable.

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Second section: a second house reverses the benefit

The second section as per the act

(explanation follows below)

(2) Where the assessee purchases, within the period of one year after the date of the transfer of the original asset, or constructs, within the period of three years after such date, any residential house, the income from which is chargeable under the head 'Income from house property', other than the new asset, the amount of capital gain arising from the transfer of the original asset not changed under section 45 on the basis of the cost of such new asset as provided in clause (a), or, as the case may be, clause (b), of sub-section (1), shall be deemed to be income chargeable under the head 'Capital gains' relating to long-term capital assets of the previous year in which such residential house is purchased or constructed.



Understanding the second section

If another house is constructed/purchases within the same period (1 year for purchase / 3 year for construction) which is eligible for ‘income from house property’ i.e. given on rent, then the tax benefit received on the new asset construction is reversed and has to be paid in the previous financial year. This rule effectively means that:

  • you sell 50 lakhs of mutual funds to buy a house (H1). The capital gains tax saved is ₹5 lakhs
  • within 3 years of the sale of the MF, you buy/construct another house (H2)
  • then the ₹5 lakh tax becomes payable in the financial year preceding the purchase of H2. This is of course not a problem if you don’t buy H2

Third section:

The third section as per the act

(explanation follows below)

(3) Where the new asset is transferred within a period of three years from the date of its purchase or, as the case may be, its construction, the amount of capital gain arising from the transfer of the original asset not charged under section 45 on the basis of the cost of such new asset as provided in clause, (a) or, as the case may be, clause (b), of sub-section (I) shall be deemed to be income chargeable under the head 'Capital gains' relating to long-term capital assets of the previous year in which such new asset is transferred.'.



Understanding the third section

Related:
This article gives worked-out examples for calculating capital gains for mutual funds and real estate.

If the new house is sold within three years of purchase / construction, the capital gains tax becomes payable in the financial year preceding the purchase of the house.

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This post titled Sec 54F: a hack that can save lakhs in taxes when you buy a house first appeared on 10 Jul 2022 at https://arthgyaan.com


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