When you sell a house, you can claim exemption from capital gains tax by reinvesting the profit in another residential property. This is allowed under Section 54 of the Income Tax Act.
In Mumbai, Kavita Damani followed this rule by using ₹3.96 crore from the sale of a property to buy a flat from her husband. However, the assessing officer (AO) rejected her claim for tax exemption, arguing that the reinvestment wasn’t genuine and that the transaction was merely a way to transfer the capital gains to her spouse and not a real purchase.
However, the Mumbai Income Tax Appellate Tribunal (ITAT) ruled in Kavita’s favour and allowed her the exemption under Section 54.
What was the case?
Kavita Damani and her husband Manoj Damani had jointly purchased two adjacent flats in Powai in March 2002. In April 2017, the husband gifted his 50% share to her, making Kavita the sole owner.
In January 2020, she sold the flats for ₹5.98 crore, earning long-term capital gains of ₹4.21 crore. She then purchased a flat in Lodha Estella from her husband in March 2021 for ₹3.85 crore and paid ₹11.55 lakh in stamp duty to claim a total of ₹3.96 crore in exemption from capital gains tax under Section 54.
She made the entire payment within the stipulated deadline under Section 54.
However, the assessing officer denied the exemption on the grounds that the reinvestment in property was not a genuine transaction because it was bought from the spouse. The AO’s argument was that Kavita had failed to prove her own contribution in the original Powai flats and that her name was included only nominally. Hence, the capital gains from the Powai flats should be taxed in her husband’s hands, as per the clubbing provisions under Section 64.
The ₹3.96 crore gains were added to her taxable income. The Commissioner of Income Tax (CIT Appeals) upheld the AO’s findings, after which Kavita approached the ITAT.
The ITAT, on reviewing the case documents, ruled that Kavita was indeed the sole legal owner of the Powai flats after the 2017 gift deed. The capital gains on the sale of the Powai flats were credited to her bank account and all disclosures were made in her income tax return.
An tax expert said, the court noted that irrespective of the fact that the details of the payments made while purchasing the Powai property in 2002 were not available, the husband had gifted his rights in the property to Kavita.
True owner
“By virtue of the said gift, Kavita had become the owner of the said property. The court further noted that tax on the rental income earned from the property was also fully paid by Kavita from the day on which the husband of assessee gifted her share to the assessee,” he explained.
This reasoning established Kavita as the real and economic owner of the Powai property.
The next question was whether the Lodha flat purchase was genuine because it was bought from her husband. Another tax expert said, the ITAT considered the transaction genuine on four key grounds.
“One, Kavita paid her husband through a bank transfer, establishing a genuine payment trail. Second, a sale deed was registered. Third, she transferred the gains within two years, which is the requirement under Section 54. Last, she deducted TDS on the sale amount and deposited it with the government,” he said.
Since Kavita met all the legal and tax requirements, the authenticity of the transaction took precedence over the relationship between the parties.
“The court observed that the relationship between the purchaser and seller is not relevant and there is no restriction on purchase of the residential property from the spouse for 54 exemption,” Wadhwa said.
Section 54 exemption between relatives
This case shows that the Section 54 exemption can be claimed even in transactions between relatives provided the eligibility criteria are satisfied:
a) the capital gains are reinvested in a residential property, and
b) within two years, or three years if the property is being constructed.
It is important that both the relatives maintain genuine transactions and proper documentation.
However, there are still costs to bear. The buyer will need to pay stamp duty, though they are allowed to include stamp duty as part of cost of acquisition and investment for exemption under Section 54.
The seller needs to pay tax on the capital gains made by selling the property since it’s not a gift. Bangar said in the case of Kavita, since she has actually paid her husband, capital gain provisions will apply in her husband’s hands.
“If the difference between the purchase and sale price is minimal, it can be advantageous for the spouses,” he explained.
Another tax expert said, such transactions carry convenience value.
“The property and control over it stays within the family,” he said.
He added it can be beneficial in specific cases such as when the husband reinvests the gains in tax-saving bonds or the capital gains liability in his hands is minimal after indexing the cost of the acquisition.
Relatives can execute the sale based on the circle rate, even if the market value is higher, which helps reduce the capital gains tax liability for the seller. The stamp duty in such cases will also be lower as it is paid on the ready reckoner rate or the actual sale consideration, whichever is higher.
