When an individual sells a capital asset, such as a residential property, the capital gains tax liability arises on the difference between the sale price and the cost of acquisition. However, the Income Tax Act, 1961 provides relief to individuals by allowing them to claim exemptions on the capital gains if the proceeds from the sale are reinvested in residential property. This is governed under Section 54 of the Income Tax Act.

Section 54 allows for the exemption of capital gains tax when the proceeds from the sale of a long-term capital asset (such as a residential property) are used to purchase one residential property. However, the question often arises: What if the proceeds are reinvested in multiple residential properties instead of just one?

In this blog, we will explore the tax implications of reinvesting the proceeds from the sale of a capital asset into multiple residential properties and how it aligns with the provisions of Section 54.

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What Does Section 54 Say?

Section 54 of the Income Tax Act provides a tax exemption for long-term capital gains arising from the sale of residential property if the proceeds are reinvested in a new residential property. The key provisions under Section 54 include:

• The capital gain from the sale of a long-term residential property is exempt from tax if the entire net sale proceeds are invested in the purchase or construction of one new residential property.
• The property purchased must be located in India.
• The property must be held for at least 36 months to qualify as a long-term capital asset.
• The reinvestment must occur within two years from the sale date (for purchase) or three years (for construction).

While Section 54 clearly specifies reinvestment in one residential property, the treatment of reinvestment in multiple residential properties has been subject to interpretation.

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Tax Implications of Reinvesting in Multiple Residential Properties

If the proceeds from the sale of a capital asset are reinvested in multiple residential properties instead of just one, the taxpayer may not be able to claim the full capital gains exemption under Section 54. Here’s why:

1. Section 54 Only Provides Relief for One Property

The most significant restriction under Section 54 is that it allows exemption for the purchase or construction of only one residential property. If the proceeds are reinvested in more than one residential property, the exemption may not apply fully or at all, depending on how the investment is structured.

In such cases, the exemption may be allowed only on the portion of the capital gain that is reinvested in one residential property. The remainder of the gain that is not reinvested in the qualifying property may become taxable.

2. Apportionment of Capital Gain

When the proceeds are reinvested in multiple properties, the taxpayer will likely face the following scenario:

• The capital gain exemption is apportioned based on the amount reinvested in each property.
• If the total gain is more than the amount reinvested in one of the properties, the portion of the gain that exceeds the reinvested amount may be subject to capital gains tax.

3. Clarification from Tax Authorities

The Income Tax Department has not provided clear guidance on this issue in the form of judicial pronouncements or circulars. However, in many cases, tax courts have ruled that Section 54 applies to a single property only, even if the taxpayer reinvests the proceeds in more than one property. Thus, there may be a disallowance of the exemption for the portion of the sale proceeds reinvested in more than one property.

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Example of Capital Gains Tax Implications When Proceeds Are Reinvested in Multiple Properties

Let’s consider an example to understand the tax implications better:

Details	Amount (₹)
Sale Price of Property	₹80,00,000
Long-Term Capital Gain	₹40,00,000
Proceeds Reinvested in Two Properties	₹35,00,000 (₹20,00,000 in Property 1, ₹15,00,000 in Property 2)
Capital Gain Eligible for Exemption	₹20,00,000 (Exemption only for Property 1)
Taxable Capital Gain	₹20,00,000 (Capital gain portion for Property 2)

In this case:

• The capital gain from the sale is ₹40,00,000.
• ₹35,00,000 is reinvested in two properties, with ₹20,00,000 allocated to Property 1 and ₹15,00,000 allocated to Property 2.
• Section 54 provides exemption only for the portion invested in Property 1, which is ₹20,00,000.
• The remaining ₹20,00,000 (for Property 2) will be subject to capital gains tax as it does not qualify for exemption.

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Tax Treatment of Multiple Residential Properties Under Other Sections

If an individual wishes to claim tax exemption for the purchase of multiple properties, they may explore other provisions under the Income Tax Act:

1. Section 54F – Reinvestment in Residential Property

Section 54F provides a broader exemption on capital gains arising from the sale of any long-term capital asset (not necessarily a residential property) if the proceeds are reinvested in one residential property. However, Section 54F allows for multiple properties if the sale proceeds are reinvested in a single property.

• The key difference is that Section 54F applies to the sale of any asset (not just residential property) and offers a broader scope for reinvestment. However, it is still restricted to one property for exemption.

2. Section 54EC – Reinvestment in Specified Bonds

Section 54EC allows exemption on long-term capital gains if the proceeds are reinvested in specified bonds (e.g., bonds issued by the government or other notified entities). This section is applicable when the taxpayer wishes to invest in bonds rather than residential property.

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Conclusion

Section 54 offers valuable relief for capital gains tax when proceeds from the sale of a long-term residential property are reinvested in one residential property. However, if the sale proceeds are reinvested in multiple properties, the capital gains tax exemption may be partially available, with the taxpayer likely losing the exemption on the portion of the gain reinvested in properties beyond the first one.

The exemption under Section 54 is specifically intended for one residential property, and reinvestment in more than one property could result in capital gains tax on the portion that exceeds the amount reinvested in a single property. Taxpayers should consider this limitation when structuring their reinvestment to maximize the tax benefits.

To ensure proper compliance with tax laws, it is essential to consult a tax professional for accurate capital gains tax calculations and explore alternative options like Section 54F or Section 54EC for reinvestment.

Additional Resources

Learn more about Tax Provisions on the official Income Tax India website.

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