Can delayed home construction cost you Section 54 relief? ITAT answers

A taxpayer who sold a residential property and claimed exemption from long-term capital gains (LTCG) tax under Section 54 cannot be denied the benefit merely because construction of the new house was delayed beyond the prescribed three-year period due to the Covid-19 pandemic, the Chennai bench of the Income Tax Appellate Tribunal (ITAT) has ruled.

According to an ET Wealth report, the Tribunal allowed the taxpayer’s claim after noting that the delay was caused by extraordinary circumstances during the pandemic and that the taxpayer had made a genuine investment towards constructing a residential house.

What was the case?

The case involved Rajan from Ambattur, Chennai, who sold his residential property in Noida on 9 July 2019 for ₹48 lakh. After claiming the indexed cost of acquisition, he computed long-term capital gains of ₹5.59 lakh.

Rajan purchased a 1,851 sq. ft. plot in Ambattur, Chennai, for ₹94.38 lakh with the intention of constructing a residential house. He also availed a loan of ₹49.85 lakh to finance the purchase and claimed exemption under Section 54 of the Income-tax Act, 1961 against the capital gains arising from the sale of the Noida property.

However, the Covid-19 pandemic and the nationwide lockdown disrupted construction activity, leading to labour shortages and delays. As construction was not completed within the statutory three-year period, the Income Tax Department denied the exemption and raised a tax demand.

The taxpayer challenged the decision before the ITAT after the Commissioner of Income Tax (Appeals) upheld the assessment.

Why did the Income Tax Department reject the claim?

The Assessing Officer held that the taxpayer had only invested in a vacant plot and had failed to establish that construction of the residential house was completed within the prescribed three years under Section 54.

The officer also noted that the unutilised capital gains had not been deposited under the Capital Gains Account Scheme. On these grounds, the exemption of ₹5.59 lakh claimed under Section 54 was disallowed.

In addition, the Assessing Officer added ₹7.42 lakh to the taxpayer’s income under Section 56(2)(x), as the stamp duty valuation of the property purchased in Chennai exceeded the actual purchase price by around 7.86%.

What did the ITAT rule?

The Chennai ITAT held that Section 54 is a beneficial provision intended to encourage investment in residential housing and should therefore be interpreted liberally.

The Tribunal observed that the law primarily requires reinvestment of capital gains in purchasing or constructing a residential house within the prescribed period and does not mandate production of a completion certificate.

It further held that exemption should not be denied merely because certain finishing works extended beyond the three-year limit, particularly when the taxpayer had already purchased the land, obtained the necessary approvals and substantially completed construction.

The Tribunal also took note of the fact that the relevant period overlapped with the Covid-19 pandemic, when nationwide lockdowns, labour shortages, disruptions in construction material supply and restricted functioning of government departments affected construction activity. It held that delays arising from such extraordinary circumstances could not be treated as negligence on the part of the taxpayer.

Accordingly, the Tribunal directed the Assessing Officer to allow the Section 54 exemption of ₹5.59 lakh.

What is Section 54 exemption?

Section 54 of the Income-tax Act, 1961, now replaced by Section 82 of the Income-tax Act, 2025, allows individuals and Hindu Undivided Families (HUFs) to claim exemption from long-term capital gains tax arising from the sale of a residential house, provided the gains are reinvested in another residential house in India within the prescribed timelines.

The exemption is available if the taxpayer purchases a residential house within one year before or two years after the transfer of the original property, or constructs a residential house within three years from the date of transfer. Subject to the conditions under the law, the exemption is generally limited to the amount invested in the new residential property.