Section 54/54F Exemption: Small House Can Get Big

When a taxpayer earns a long-term capital gain from the sale of any capital asset, investing in a residential house within a specified period can provide an exemption under Section 54/54F of the Income Tax Act, 1961. However, Taxpayers  often face challenges  in claiming these exemptions due to objections raised by  tax authorities. In this   article, We will  examine various critical aspects of Section 54/54F exemptions based on landmark judgments.

1. Small Residential House on Large Land: Is Size a Constraint?

In a given case where an assessee sold commercial property and constructed a very small residential house consisting of two rooms, a kitchen, and a bathroom and with the land size was  very big.    The Cost of Construction is very small when compared to the cost price of Land. The assessee submitted a valuation report , Which revealed that the assessee had constructed a residential building with electricity and water connection, and used it as a  residential unit.The assessee has claimed exemption u/s 54F.

However , the Commissioner (Appeals) has  restricted the deduction to the constructed portion only. The CIT(A) observed that a very small residential house constructed as compared to the land size and the exemption benefits cannot be extended to the land appurtenant is also not tenable in law.

Upon appeal to the Tribunal , the Delhi Tribunal in Girish Mohan v. ACIT (2023) ruled that the size of the constructed house in proportion to the size of  land is immaterial for claiming exemption under Section 54F. The tribunal also held that the house constructed on agricultural land or on other land does not matter, but the fact matters that the residential house is constructed.

2. Commercial/Residential Use of Property: Is It Relevant?

The issue of whether a property must be used exclusively for residential purposes to qualify for exemption under Section 54F has been examined by various ITAT benches.

In Mahavir Prasad Gupta v. Jt. CIT (ITAT Delhi), the assessee sold shares and he invested the amount of  Long  Term Capital Gain in a new residential property. However, the CIT(A) denied the exemption u/s 54F , citing that the property was let out for commercial use and lacked a kitchen facility Therefore It could not qualify to be a residential House.

The assessee contended that the property was originally intended for residential purposes and that its commercial use was incidental. The letting out by the assessee of the superstructure for commercial purposes was not the intention and was merely incidental, done with the purpose of earning some rentals. It was argued that the conditions specified in Section 54F merely require an assessee to invest in a residential house and there was no stipulation that the same be also used as a residential house. It was submitted that the letting out for commercial purposes was only a temporary phenomenon and does not distract from the fact that the property remained a residential property.

The ITAT Delhi Bench ruling clearly states that The use of the property is not the relevant criterion to consider the eligibility of Section 54F benefit. A bare reading of the provisions of Section 54F reflect that what is required is investment in a new residential house. Therefore, the question that arises in the instant case is whether the new property constructed by the assessee is a residential house or not. Mere non-residential use would not render a property ineligible for the Section 54F benefit if it otherwise is a residential house. 

3. Residential House on Agricultural Land: Section 54 Exemption

In this case the assessing officer found that  the assessee purchased agricultural land measuring 87,120 sq. ft. It is further observed that land in question is being used as Farm house and that the residential house is constructed in  (1,350 sq. ft.), along with a guest house(900 sq. ft.), staff quarters & toilets (500 sq. ft.), a swimming pool(400 sq. ft.), and sheds for parking and pets (1,800 sq. ft.),Based on the report ,the land is still classified as agricultural in revenue records.

The ITAT Delhi, in DCIT v. Kanwal Mohan Singh Sehgal, ruled that:

1. A farmhouse is also  a residential house.

2. Assessee has built a small house compared to the size of land, but section 54 does not put any rider that deduction in respect of investment in acquisition of land appurtenant to the building will not qualify for exemption.

3. It is not in dispute that the assessee has purchased agricultural land and constructed in the said land a residential house, guest house, staff quarters, swimming pool & shed for parking, etc. The assessee has made an investment in the residential house and land appurtenant thereto, and the Act does not limit the size of appurtenant land. 

4. The tribunal also held that the house constructed on agricultural land or on other land does not matter, but the fact matters that the residential house is constructed

Conclusion

These judgments reaffirm that Section 54/54F exemptions apply as long as a residential house is constructed, irrespective of land size or incidental commercial use. Taxpayers investing in residential properties to claim exemptions should be aware of these precedents to strengthen their claims.

Disclaimer

This article is intended for informational purposes only. Taxpayers should consult their Chartered Accountants or tax advisors before making any decisions. The author is not responsible for any loss incurred due to reliance on this article.