Long term capital gains on sale of property is exempted from tax to the extent it is utilized to purchase another residential house within one year before or two years after the transfer of long term capital asset as per section 54 of the Income Tax Act. For construction of house , the time limit is three years. But the question , this post is answering , can the claim of exemption u/s 54 valid when the sales amount of the long term property is used for paying installment or construction of the house which was started construction much earlier than the financial year in which the sale/transfer of the asset took place.
Payment for Flat Booked or Construction Started
If one pays the installment out of sale proceeds of the house bought in 2006 for a house booked in 2012 , in my considered opinion , he should get the exemption for the amount of investment. This is because section 54 of the Income Tax Act nowhere states that the property bought one year before should be a NEW property .
Secondly , when the legislature provides that the condition of buying property for exemption under section 54 as under :
One year before the sale (transfer)
2 years after ( 3 years for construction).
The moot question to ponder is how tax can payer uitilize the money out of sale , one year before when he did not get money for sale of the property at all . In my considered opinion, what the legislature has provided that if the property is bought earlier and for that property the long term capital gains is utilized in such circumstances , tax should not be imposed to the extent capital gains was utilized.
So, if the long term capital gain is Rs 100 and the he paid /invested Rs 30 for house booked earlier than FY 2015-16 , he can claim exemption upto Rs 30 , because the investment was out of capital gains to the extent of Rs 30 . That is what , in my opinion, was the condition for claiming exemption u/s 54.
In this regard the decision of Hyderabad ITAT, DCIT , Circle 3(1) vs Sri Vidyasagar Dontineni  57 taxmann.com 110 (Hyderabad – Trib.) is very relevant . The ITAT had considered exactly such a situation existed in case of an assesse who claimed exemption u/s 54 on investment for constructing a house , the land a bought much earlier than the sale of the house .The Assessing Officer did not allow the claim on the ground that the construction of house had commenced way back in April, 2002 and there was already a house in habitable condition much before the transfer of new assets by the assessee during the years under consideration.
The Commissioner (Appeals) however held that the claim of assesse was allowable on facts of the case . He further held that section 54 merely specifies the date by which construction should be completed and therefore, the fact that the assessee had initiated construction much before the transfer of a capital asset did not disentitle him from claiming deduction under section 54.
The department appealed before tribunal , which dismissed the appeal stating as under :
8.1 A careful reading of the relevant provisions of section 54 makes it clear that the capital gain arising from the transfer of long term capital asset being the residential house is eligible for deduction under section 54 to the extent the same is invested or utilized during the specified period for purchase or construction of a residential house. There is however, nothing to show that such a residential house has to be only a new residential house and not a old residential house. Such a residential house is referred to as “the new asset” in clauses (i) and (ii) of sub-section(1) of section 54 in order to distinguish it from the similar expression “a residential house”, the transfer of which has given the rise to the capital gain used in the same provisions. What therefore is envisaged in section 54 for claiming deduction is the investment made in purchase or construction of residential house and not new residential house as interpreted by the A.O. As rightly held by the Ld. CIT(A), in this context, although there was an old structure on the plot of the assessee at Jubilee Hills which was demolished and the construction of new house had commenced way back in the year 2002-2003, the date of commencement of construction is not relevant for the purpose of deduction under section 54 and what is relevant is the date of completion of the construction as well as the period of investment made by the assessee in such construction. In this regard, there is no dispute that the amount in question spent by the assessee on construction of the residential house was within the specified period and that the construction of house was completed on 28.06.2010. As such, considering all the facts of the case, we are of the view that the assessee is eligible for deduction under section 54 to the extent allowed by the Ld. CIT(A) in both the years under consideration and we find no justifiable reason to interfere with the impugned orders of the Ld. CIT(A) on this issue. The same are therefore upheld and these appeals filed by the Revenue are dismissed.
9. In the result, appeals of the Revenue are dismissed.
The second case is that of Karnataka High Court in case of Commissioner of Income-tax vs. J.R. Subramanya Bhat  28 TAXMAN 578 (KAR.) in which the fact was that the assessee sold the building on 9-2-1977 for Rs. 1,20,000. He worked out the capital gains at Rs. 83,968 which he claimed as exempt from tax under section 54 of the Act. Sometime earlier to March 1976 he commenced construction of a new house. It was evidently clear prior to the sale of his old house. He completed the construction of the new house in March 1977.
In simple words ,he sold the building in Feburary 1977 and claimed exemption for investment in property , construction of which was started much earlier i.e March 1976.
A.O did not allow the exemption on many grounds. One of them was that constriction started before sale of the property. CIT(A) and Tribunal , however allowed assesse’s case.The case ultimately reached Karnataka High Court ,that held in favour of assesse stating that
i. the exemption u/s 54 is allowable to assesse.
ii. It is immaterial when the construction commenced earlier. What was important was whether the construction was completed within two years after the transfer of sold house.
The excerpt of relevant portion is as under :
Under this section if the assessee has within a period of one year or after the date on which the transfer took place purchased or has within a period of two years after that date constructed a residential house, then, instead of the capital gain being charged to income-tax as income of the previous year in which the transfer took place, it shall be dealt with in accordance with the other provisions set out in the said section.
The Tribunal on an appreciation of the evidence has firstly found that the building was used by the assessee mainly for his residential purpose. Taking into consideration the area of the building under the occupation of the assessee, it has stated that the ground floor occupied by the assessee including the garage was 1,330 sq. ft. The land appurtenant to the ground floor, excluding the land occupied by the house was 4,795 sq. ft. that was also held to be under the occupation of the assessee. This building with the land has been sold. It was only the first floor that was let out. The Tribunal took into consideration the extent of the building used mainly for the residential purpose of the assessee and found that the major portion of the building was under the occupation of the assessee. The Tribunal, therefore, concluded that the first condition prescribed under section 54 was satisfied. This finding, it may be seen, has been arrived at by the Tribunal upon appreciation of the evidence and the factual aspects of the case.
6. So too the next conclusion reached by the Tribunal. The date of the sale of the old building was 9-2-1977. The completion of the construction of the new building was in March 1977 although the commencement of the construction started in 1976. It is immaterial as the Tribunal, In our opinion, has rightly observed about the date of commencement of the construction of the new building. Since the assessee has constructed the building within two years from the date of sale of the old building, he was entitled to relief under section 54.
If one pays for a under constructed house or booked flat earlier than the house sold , still he can claim exemption u/s 54 to the extent he /she invested in the residential house. Will there be objection from tax department. Yes, but chances of winning the case in appellate proceeding is 90%