Statutory Framework: Section 54 of the Income-tax Act, 1961
Section 54 provides for exemption from long-term capital gains (LTCG) arising from the transfer of a residential house property, if the assessee invests in another residential house within prescribed timelines.
Key Conditions:
The asset transferred is a long-term capital asset, being a residential house property (buildings or lands appurtenant).
The assessee is an individual or HUF.
The capital gains are invested in purchase of one residential house in India within one year before or two years after the transfer, or in construction within three years.
From AY 2020–21, a one-time option is available to invest in two houses if capital gains ≤ ₹2 crore [Finance Act, 2019].
From AY 2024–25, a monetary cap of ₹10 crore has been introduced on capital gains eligible for exemption [Finance Act, 2023].
The Common Controversy: Sale of Two Flats, Investment in One – Is Section 54 Available for Both?
Practical Issue:
An assessee sells two separate residential flats, resulting in two separate LTCGs, and invests the combined capital gains into one new residential flat. The Assessing Officer questions the allowability of Section 54 exemption for both gains, especially in cases where notices under Section 143(2) or Section 142(1) are issued.
Judicial Precedents Supporting the Claim
1. CIT v. K.G. Rukminiamma (2011) 331 ITR 211 (Kar HC)
Held that if multiple flats were used as a single residential unit, the exemption under Section 54 is allowable. While this case dealt with multiple units acquired, the principle of residential intent and functional unity is crucial.
2. DCIT v. Ranjit Vithaldas [2012] 23 taxmann.com 226 (ITAT Mumbai)
Held: Even if there are multiple properties sold and only one new residential house is purchased, exemption u/s 54 cannot be denied if all other conditions are met. Each sale triggers its own capital gains but reinvestment in one house suffices.
3. ITO v. Ms. Sushila M. Jhaveri [2007] 107 ITD 327 (Mum) (SB)
Special Bench held that the term “a residential house” should be interpreted in a liberal, purposive sense, especially when the reinvestment is in a single dwelling unit.
4. V.R. Karpaam v. ITO [2013] 143 ITD 126 (Chennai – Trib)
Held: Section 54 does not restrict exemption only if one asset is sold. If multiple residential houses are sold, and investment is made into one residential house, Section 54 can apply to the respective capital gains, if timing and conditions are met.
Law Language and Interpretation
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The expression “a residential house” has been judicially interpreted not as a numerical singularity, but as referring to a single residential unit, regardless of its architectural configuration or the number of assets sold.
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The mischief rule of interpretation suggests that Section 54 intends to promote reinvestment into residential use, and not to restrict relief where multiple sales fund one reinvestment.
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However, Section 54F, applicable for sale of capital assets other than residential house, specifically requires that the assessee does not own more than one residential house, suggesting a stricter regime.
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Section 54 allows multiple LTCG events to be sheltered if the investment event is singular and compliant.
FAQs — Clarifying Edge Cases and Compliance
Q1. Can I claim exemption under Section 54 for sale of two houses and reinvestment into one flat?
Yes, as long as:
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Both houses sold were long-term capital assets.
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Each qualifies as a residential house.
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The reinvestment is in a single residential house, within the timelines.
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Document trail proves the identity and purpose of the new residential house.
Q2. Does the exemption get denied just because two separate capital gains are involved?
No. Judicial rulings support the view that multiple LTCGs can be claimed under Section 54, provided the investment is traceable and compliant.
Q3. Is there any risk due to “a residential house” being singular in the statute?
There is a linguistic ambiguity, but courts have consistently interpreted the phrase purposively, treating one dwelling unit as qualifying, regardless of the number of sources of capital gains.
Q4. How does the Finance Act, 2023 amendment affect this?
From AY 2024–25, the maximum capital gain eligible for exemption under Section 54 is ₹10 crore, irrespective of number of houses sold or purchased.
Q5. Can this exemption be denied during assessment or scrutiny?
While exemptions may be disputed, supportive case law, clear documentation, and consistency in return filing strengthen the claim.
Strategic Compliance Guidance
1. Ensure Usage & Ownership Consistency
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Both flats sold must be residential in nature—not commercial or let-out with business usage.
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Avoid discrepancies in usage history (e.g., declaring one as self-occupied and other as rented).
2. Maintain a Robust Paper Trail
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Sale deeds, computation sheets, reinvestment agreement, and bank statements must clearly correlate each LTCG with the reinvestment.
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Investment should be in the name of the assessee to avoid disqualification (except in some judicially upheld cases involving joint ownership with spouse).
3. Timing Is Critical
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Reinvestment must be made within 1 year before or 2 years after transfer (purchase) or within 3 years (construction).
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If not yet invested before return filing due date under section 139(1), deposit gains in Capital Gains Account Scheme (CGAS).
4. Separate Disclosure in Return
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Disclose each LTCG transaction separately and claim exemption under Section 54 accordingly.
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Attach computation and reference judicial precedent in case of high-value claims.
5. Cite Case Laws in Assessment Replies
If a 143(2) or 142(1) notice is received, reply with:
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Detailed working of each gain and reinvestment
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Judicial rulings cited above
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Clarification that investment was into “a residential house” and satisfies the spirit of Section 54
Conclusion
The exemption under Section 54 can be legitimately claimed on capital gains from sale of two residential houses if invested into one new residential house, as long as statutory timelines and usage conditions are met. Judicial authorities have favored liberal interpretation when the taxpayer’s intent aligns with reinvestment in residential property. However, the Finance Act, 2023 ₹10 crore cap, and the need for precise disclosure, demand high-quality documentation and professional diligence.
