Section 54 Exemption: How to Save Tax on Sale of Residential Property
- PRITI SIRDESHMUKH
- Nov 5
- 9 min read
Section 54 of the Income Tax Act, 1961 offers a major tax relief for homeowners selling a residential property. If the profit from the sale is reinvested in another residential house, the capital gains can be exempted from tax. This provision ensures that taxpayers who continue investing in housing assets are not burdened with capital gains tax, provided they meet specific timelines and conditions. The exemption applies only to long-term capital gains and is available to individuals and Hindu Undivided Families (HUFs).
Taxpayers can save tax on residential property sales by reinvesting the capital gains in a new property within the prescribed period under Section 54, ensuring the investment complies with the eligibility and timeline criteria.
Table of Contents
Understanding Section 54 Exemption of the Income Tax Act
Section 54 of the Income Tax Act, 1961 provides relief from long-term capital gains tax on the sale of a residential property when the gains are reinvested into another residential house. This exemption is specifically available to individuals and Hindu Undivided Families (HUFs). The intent behind this provision is to promote reinvestment in housing and support taxpayers who shift their residential assets rather than liquidate them for other purposes. The exemption applies only to long-term capital gains, meaning the property sold must have been held for more than 24 months before transfer.
Conditions to Claim Tax Exemption Under Section 54
To avail of the exemption, the taxpayer must meet specific conditions:
The capital gains must be reinvested in the purchase of a new residential property within one year before or two years after the date of sale of the original property.
If the taxpayer opts to construct a new house, construction must be completed within three years from the date of sale.
The exemption is allowed for investment in one residential property only. However, under certain conditions, investment in two properties may be allowed if the capital gain does not exceed ₹2 crore, and this option can be exercised only once in a lifetime.
If the amount is not immediately used for the purchase or construction, it must be deposited in a Capital Gains Account Scheme (CGAS) before the due date of filing the return under Section 139(1).
Failure to comply with these conditions may lead to withdrawal or partial reduction of the exemption.
How to Calculate Capital Gains for Section 54 Exemption
The capital gain eligible for exemption is computed by subtracting the indexed cost of acquisition and improvement from the sale consideration. If the entire capital gain is reinvested in a new property, the exemption is for the full amount. If only a part is reinvested, the exemption is limited to the portion invested.
Formula: Long-Term Capital Gain = Sale Value – (Indexed Cost of Acquisition + Indexed Cost of Improvement + Expenses on Transfer)
If the new property is sold within three years of purchase or construction, the exemption claimed earlier is withdrawn, and the amount becomes taxable as short-term capital gain in the year of sale.
Example of Section 54 Exemption Calculation
Suppose a residential property is sold for ₹90,00,000, and the indexed cost of acquisition is ₹50,00,000. The resulting long-term capital gain is ₹40,00,000. If the taxpayer invests ₹40,00,000 or more in a new residential house within the stipulated timeline, the entire gain becomes exempt. If the investment is only ₹25,00,000, the exemption will be limited to ₹25,00,000, and the remaining ₹15,00,000 will be taxable.
This provision ensures that even partial reinvestment allows partial relief, encouraging taxpayers to reinvest their gains according to financial capacity.
How to Claim Section 54 Exemption in ITR Filing
To claim the exemption, taxpayers must report the transaction under the “Capital Gains” schedule in their Income Tax Return (ITR). The following details are typically required:
Date of purchase and sale of the old and new property
Sale consideration and cost details
Amount invested in the new property or deposited in CGAS
Supporting documents like sale deed, purchase agreement, and proof of investment
Platforms like TaxBuddy simplify this process by guiding users through each step — from identifying eligible gains to entering details correctly in ITR forms. TaxBuddy also tracks exemption timelines and ensures accurate claim reporting, helping users avoid errors and scrutiny.
Section 54 vs Section 54F vs Section 54EC
While Section 54 deals with sale and reinvestment of a residential house, Section 54F provides similar benefits when any long-term capital asset (like land, gold, or shares) is sold, and the proceeds are invested in a residential house. Section 54EC, on the other hand, allows exemption by investing long-term capital gains in notified government bonds, such as NHAI or REC bonds, within six months of the sale.
Each section has distinct conditions and benefits. For instance, Section 54 applies only when both the old and new assets are residential properties, whereas Section 54F applies when the old asset is non-residential. Section 54EC offers a low-risk investment route with a maximum limit of ₹50 lakh per financial year.
Recent Updates and Notifications for FY 2024-25
The Union Budget 2025 introduced clarifications for capital gains exemptions, reaffirming that the new tax regime does not allow deductions or exemptions under Section 54. However, taxpayers opting for the old regime continue to enjoy full benefits if the conditions are met. The CBDT also issued notifications simplifying the compliance process, such as updated guidance for e-filing and automatic linking of CGAS deposits with the income tax portal for verification.
Common Mistakes to Avoid While Claiming Section 54 Exemption
Common mistakes while claiming Section 54 exemption often occur due to oversight of timelines or procedural lapses, which can lead to loss of tax benefits. One of the most frequent errors is missing the investment deadline for purchasing or constructing the new property. The Income Tax Act clearly specifies that the new property must be purchased within one year before or two years after the sale of the original property, or constructed within three years. Delays beyond this period can result in the exemption being denied, even if the intention to reinvest was genuine.
Another mistake taxpayers make is using the sale proceeds for non-qualifying purposes before reinvestment. Once the property is sold, the capital gains should either be directly used to purchase or construct the new residential property or deposited in the Capital Gains Account Scheme (CGAS) if the purchase or construction is not completed before the filing deadline. Any interim use of these funds for personal or unrelated financial purposes invalidates the exemption claim, as the law requires a clear trail showing the reinvestment of capital gains.
Failing to deposit unutilized gains in the Capital Gains Account Scheme before the due date of filing the income tax return is another common issue. The CGAS serves as a temporary holding account that allows taxpayers to preserve their exemption eligibility until the investment is made. If the unutilized amount is not parked in this account by the due date, the tax authorities may treat the uninvested portion as taxable capital gains.
Misreporting the date of possession or registration can also create complications. For claiming exemption, both the date of sale of the old property and the date of purchase or completion of construction of the new property must align with the prescribed timelines. Errors in recording these dates can lead to disputes during scrutiny, as the exemption depends on strict adherence to these conditions.
Selling the new property within three years of purchase or construction reverses the exemption benefit completely. If this happens, the amount previously exempted becomes taxable as short-term capital gain in the year of sale. This rule ensures that the benefit is used for genuine reinvestment in housing and not for short-term profit.
Avoiding these mistakes is essential to ensure uninterrupted exemption under Section 54 and a smooth verification process during income tax assessments. Proper documentation, timely reinvestment, and professional guidance from platforms like TaxBuddy can help taxpayers claim exemptions accurately and avoid compliance errors that may otherwise lead to disallowance or penalties.
Conclusion
Section 54 is one of the most effective ways for homeowners to reduce capital gains tax liability legally. By reinvesting in another residential property and adhering to the timelines, taxpayers can secure substantial savings while remaining compliant. Digital filing platforms like TaxBuddy make it easier to claim such exemptions accurately, providing expert guidance and automatic validation of key details during return preparation.
For anyone looking for assistance in tax filing, it is highly recommended to download the TaxBuddy mobile app for a simplified, secure, and hassle-free experience.
FAQs
Q1. What is the time limit to buy a new house for Section 54 exemption?
The taxpayer must purchase a new residential property within one year before or two years after the sale of the old house. If opting to construct a new property, the construction must be completed within three years from the date of sale. These timelines are crucial to retain the exemption benefit, and any delay beyond the stipulated period makes the unutilized portion of capital gains taxable.
Q2. Can I claim Section 54 exemption on the sale of a second house?
Yes, the exemption can be claimed even on the sale of a second residential property, provided it was held for more than 24 months and qualifies as a long-term capital asset. However, the benefit applies only when the proceeds are reinvested into another residential house that meets the eligibility conditions. The exemption cannot be claimed if the reinvestment is made in commercial property or land.
Q3. Is loan money invested in the new property eligible for exemption?
Only the portion of the investment that comes from the actual capital gains of the sold property qualifies for exemption under Section 54. If a home loan is taken to fund part of the purchase, the exemption is available only to the extent of the capital gains invested, not for the borrowed portion. However, taxpayers can still claim other deductions like interest on home loans under Section 24(b) if applicable.
Q4. What documents are required to claim Section 54 exemption?
To claim exemption, taxpayers must maintain and submit supporting documents such as:
Sale deed of the old property
Purchase agreement or construction receipts of the new property
Proof of payment (bank statements, builder invoices, etc.)
Capital Gains Account Scheme deposit proof (if applicable)
Possession or registration documents for the new property Accurate documentation ensures a smooth verification process during tax filing or assessment.
Q5. How does the Capital Gains Account Scheme work for claiming exemption?
If the taxpayer is unable to reinvest the capital gains before the ITR filing due date, the unutilized amount can be temporarily deposited in a Capital Gains Account Scheme (CGAS) in a public sector bank. This deposit ensures eligibility for exemption until the funds are used to purchase or construct the new property within the allowed timeframe. The deposit must be used only for the intended purpose, and any unused balance after the deadline becomes taxable.
Q6. What happens if the new property is sold within 3 years of purchase?
If the newly purchased or constructed property is sold within three years, the exemption claimed earlier under Section 54 is reversed. The amount of exemption becomes taxable as short-term capital gains in the year of sale. This provision discourages quick resale and ensures that the reinvestment remains a long-term residential investment.
Q7. Can multiple houses be purchased using Section 54 exemption?
Ordinarily, the exemption is available for investment in one residential property. However, a special provision allows investment in two properties if the total capital gains do not exceed ₹2 crore. This benefit can be availed only once in a lifetime. If exercised, future claims under Section 54 will be restricted to one property only.
Q8. Is the exemption available under the new tax regime?
No, Section 54 exemption is not available under the new tax regime introduced under Section 115BAC. The new regime offers lower tax rates but disallows most exemptions and deductions. Taxpayers who wish to claim Section 54 benefits must file their return under the old tax regime and declare the option accordingly.
Q9. How to claim Section 54 exemption if the new house is under construction?
If the new property is under construction, the exemption can still be claimed, provided the construction is completed within three years from the date of sale of the old property. The taxpayer must maintain records of payments and agreements to prove ongoing construction. If construction isn’t completed within the specified period, the exemption for the unutilized portion may be withdrawn and taxed as capital gains.
Q10. Does TaxBuddy offer both self-filing and expert-assisted plans for ITR filing, or only expert-assisted options?
TaxBuddy offers both self-filing and expert-assisted plans for income tax filing. Users can choose between filing their ITR independently through the platform’s intuitive interface or opting for guided assistance from tax professionals who review, verify, and file returns on their behalf. Both options include smart checks to identify errors and maximize eligible deductions.
Q11. Which is the best site to file ITR?
For secure, accurate, and hassle-free filing, platforms like TaxBuddy are among the best choices. It combines AI-driven automation with professional assistance to ensure that exemptions such as those under Section 54 are correctly claimed. The system validates inputs, helps track investments, and ensures compliance with the latest Income Tax Department rules.
Q12. Where to file an income tax return?
Income tax returns can be filed online through the official Income Tax Department e-filing portal or through authorized platforms like TaxBuddy. Using such platforms simplifies the process with auto-filled data, integrated PAN verification, and expert review. TaxBuddy also offers a mobile app for quick uploads, exemption tracking, and seamless ITR submission, ensuring an effortless tax filing experience.
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