Section 54 Income Tax Act: Capital Gains Exemption on Residential House Property - Complete Guide FY 2026-27

Section 54 of the Income Tax Act provides one of the most valuable tax exemptions for homeowners - exemption from Long Term Capital Gains (LTCG) tax arising from the sale of residential house property, if the capital gains are reinvested in purchasing or constructing another residential property. This exemption allows individuals and Hindu Undivided Families (HUFs) to avoid paying capital gains tax when they sell their home and buy or build a new one, effectively encouraging reinvestment in residential real estate. With the maximum exemption capped at ₹10 crore from Assessment Year 2024-25 onwards (introduced by Finance Act 2023), understanding the conditions, timeline, two-house benefit, and Capital Gains Account Scheme becomes critical for tax planning. This comprehensive guide covers all aspects of Section 54 for FY 2026-27, including eligibility, mandatory conditions, calculation with examples, comparison with Section 54F, lock-in periods, and detailed FAQs.

What is Section 54?

Section 54, titled "Profit on sale of property used for residence", is contained in Chapter IV - Computation of Total Income under the head "Capital Gains". It provides exemption from long-term capital gains tax when residential property is sold and proceeds are reinvested in another residential property.

Key Features of Section 54

Who Can Claim Section 54 Exemption?

Eligible Taxpayers

• Individuals: Any individual taxpayer (resident or non-resident) who sells residential house property
• Hindu Undivided Family (HUF): HUFs owning residential property can claim this exemption

Mandatory Conditions for Section 54 Exemption

ALL the following conditions must be satisfied cumulatively. Failure to meet even one condition disqualifies the exemption.

₹10 Crore Exemption Cap - Finance Act 2023 Change

Two House Property Benefit - Special Provision

A unique feature of Section 54 allows purchase of TWO residential properties instead of one, subject to conditions.

Formula for Calculating Exemption Under Section 54

Step-by-Step Calculation Process

1. Calculate Long Term Capital Gains:
   • LTCG = Sale Consideration - Indexed Cost of Acquisition - Indexed Cost of Improvement - Transfer Expenses
   • Use Cost Inflation Index (CII) for indexation
2. Determine Investment in New Property:
   • Purchase cost as per registration deed
   • OR Construction cost (materials, labor, professional fees)
   • Exclude stamp duty, registration charges, brokerage (these are not part of purchase/construction cost for Section 54)
3. Calculate Exemption:
   • Take lower of LTCG or Investment amount
   • Apply ₹10 crore cap if applicable
4. Compute Taxable LTCG:
   • Taxable LTCG = Total LTCG - Exemption under Section 54
   • Tax rate: 12.5% for property (or 20% with indexation if acquired before 23rd July 2024)

Detailed Examples - Section 54 Calculation

Capital Gains Account Scheme (CGAS) - Mandatory Deposit

If capital gains are not immediately invested in new property, they must be deposited in CGAS to claim exemption.

Lock-in Period - 3 Years Restriction

Section 54 vs Section 54F - Key Differences

Common Mistakes to Avoid

Tax Planning Strategies with Section 54

1. Use CGAS Strategically:
   • Don't rush to purchase property immediately
   • Deposit in CGAS, get up to 2 years (or 3 for construction) to find right property
   • Claim exemption in current year, invest later
2. Optimize Two-House Benefit:
   • If capital gains around ₹2 crore, consider purchasing two smaller properties
   • Provides diversification and better rental yield potential
   • Can be in different cities
3. Combine with Section 54EC:
   • If capital gains exceed ₹10 crore, partial exemption under Section 54
   • Balance can be invested in bonds under Section 54EC (up to ₹50 lakh additional)
   • Reduces overall tax liability
4. Construction Strategy:
   • Construction gives 3-year timeline (vs 2 years for purchase)
   • Purchase plot immediately after sale
   • Construct gradually over 3 years
   • Each construction expense qualifies for exemption as incurred
5. Pre-Sale Purchase:
   • Can purchase new property up to 1 year BEFORE selling old property
   • Useful if you've already found ideal property
   • Lock-in 3 years counted from purchase date
6. HUF Property Planning:
   • If HUF sells property, can claim Section 54
   • New property can be in name of HUF
   • Separate exemption from individual members' claims
7. Timing of Sale:
   • Sell property early in financial year
   • Gives more time to find new property within same FY
   • ITR filing deadline also extends the planning window

Frequently Asked Questions (FAQs)

Key Takeaways for FY 2026-27

• Section 54 provides exemption from LTCG tax on sale of residential house property
• Applicable only to Individuals and HUFs, not to companies/firms
• Maximum exemption capped at ₹10 crore from AY 2024-25 onwards
• Must reinvest in residential property only (commercial not eligible)
• Purchase timeline: 1 year before OR 2 years after sale
• Construction timeline: Within 3 years after sale
• Two house benefit: If LTCG ≤ ₹2 crore, can purchase 2 properties (once in lifetime)
• CGAS deposit mandatory if not invested before ITR due date
• 3-year lock-in period: New property cannot be sold within 3 years
• Selling within 3 years reverses exemption and creates tax liability
• Partial investment allowed - proportionate exemption available
• Stamp duty and registration NOT included in purchase cost for Section 54
• Can purchase property before selling old property (within 1 year before)
• Overseas property investment does NOT qualify
• Exemption = Lower of LTCG or Investment amount (max ₹10 crore)

Conclusion

Section 54 of the Income Tax Act is one of the most taxpayer-friendly provisions, designed to support individuals and families in upgrading or relocating their residential accommodation without the burden of immediate capital gains tax. By allowing exemption on reinvestment in another residential property, the provision recognizes that such transactions are driven by genuine housing needs rather than profit motive, thereby promoting investment in the residential real estate sector and ensuring social housing stability.

The introduction of the ₹10 crore exemption cap from AY 2024-25 has brought some moderation to this benefit, ensuring that ultra-high-value transactions also contribute some tax to the exchequer while still providing substantial relief. For the vast majority of taxpayers dealing with normal residential properties, this cap doesn't impact their ability to claim full exemption as long as they fulfill all the mandatory conditions.

The unique feature allowing purchase of two residential properties when capital gains don't exceed ₹2 crore provides additional flexibility, enabling taxpayers to diversify their real estate investment or maintain properties in two different locations - perhaps one for self-occupation and another for rental income or future use. This once-in-lifetime benefit should be utilized strategically when the opportunity arises.

The Capital Gains Account Scheme (CGAS) is a critical enabler of Section 54, as it removes the pressure to make hasty property purchase decisions. By depositing unutilized capital gains in CGAS before the ITR filing deadline, taxpayers can claim immediate exemption while retaining up to 2-3 years to find the right property at the right price in the right location. This flexibility is invaluable in a market where property searches can take considerable time.

However, taxpayers must be acutely aware of the 3-year lock-in period for the new property. Selling within this period not only reverses the exemption but also creates significant tax liability in the year of sale due to both the reversal and the fresh capital gains on the new property sale. This lock-in should be factored into purchase decisions, ensuring that the new property genuinely meets long-term residential needs and won't require premature sale.

For FY 2026-27, as property values continue to appreciate and more taxpayers find themselves with substantial capital gains on sale of old properties, understanding and properly utilizing Section 54 becomes crucial for tax optimization. Whether purchasing an apartment, constructing an independent house, or upgrading to a villa, ensuring compliance with all Section 54 conditions - timelines, residential use, CGAS deposit, and lock-in period - will help maximize tax savings and achieve housing goals without unnecessary tax burden.

Consulting with a qualified Chartered Accountant or tax advisor before executing property sale and purchase transactions is highly recommended, especially for high-value properties where even small procedural mistakes can result in loss of substantial tax exemptions running into lakhs or crores of rupees.

Planning to Sell Your Home? Need Help with Section 54? Explore our guides on Capital Gains Tax, Cost Inflation Index, Section 50C, and Capital Gains Account Scheme for comprehensive property tax solutions.