54F Exemption 

1. Can two properties acquired be termed as a single property for the purpose of claiming exemption under Section 54F?

It is established, based on judgments, particularly the case of Nakul Aggarwal, Mumbai v. Assistant Commissioner of Income Tax, Circle-24(1), Mumbai (Income Tax Appellate Tribunal, 2024), that if two units are acquired under different agreements with the intention to combine them into one residential unit, they can be treated as a single residential house for exemption purposes under Section 54F. The Hon'ble Bombay High Court in CIT v. Devdas Naik (2014) also supports this view, stating that exemption under Section 54F would be available if two units are treated as one residential house.

The Delhi High Court, in a December 2024 judgment, clarified that the phrase "a residential house" in Section 54F generally refers to a single residential property. However, the court also established that when two flats can be combined into a single functional dwelling unit, they might qualify as one property for Section 54F exemption.

For adjacent properties to qualify as a single unit, the taxpayer must demonstrate that:

• The flats are physically adjacent and capable of being combined.

• There is clear intention to use them as a single residential dwelling.

• The properties can functionally operate as one cohesive living space.

An assessee can claim benefit under Section 54F in case he/she purchases 2 adjoining flats only when it is able to prove/justify that the two adjoining flats can be/will be combined into a single dwelling unit/a single residential house.

The fact that two properties are adjoining, registered separately for stamp duty purposes, and were acquired on the same date could suggest they are part of a single transaction or a single residential unit for the assessee's purposes. However, since the flats are registered separately, it may be challenging to argue that they constitute a single property unless there is evidence of their combined use as one unit.

2. If treated as a single property, can Section 54F be termed as revoked in FY 25-26?

If the properties are treated as a single unit for the exemption under Section 54F, the exemption would not be revoked simply based on the sale in FY 25-26. However, it is crucial that the properties must have been utilised as a single residential unit during the holding period to maintain the exemption.

Under Section 54F provisions, if a new residential house purchased with exemption is transferred within 3 years of purchase/construction, the originally exempted capital gain becomes taxable in the year of transfer.

If treated as a single property, the planned sale on April 2, 2025, after purchase on April 15, 2021, falls just beyond the 3-year holding period requirement (April 15, 2021, to April 15, 2024). Therefore, the Section 54F exemption would not be revoked since the 3-year holding requirement has been satisfied.

3. If considered as two adjacent properties, does the claim of exemption under Section 54F become invalid for FY 20-21 and FY 21-22? Does he need to file an updated return under Section 139(8A)?

If the properties are considered as two separate units and not as a single residential property, the claim for exemption under Section 54F for FY 20-21 and FY 21-22 may be invalid. The judgment in MRS. KAMLA AJMERA v. PR. COMMISSIONER OF INCOME TAX (Delhi High Court, 2024) indicates that if two residential properties cannot be treated as one, then the exemption cannot be fully claimed.

If the flats cannot be substantiated as a single unit, the original Section 54F claim would be potentially invalid as Section 54F clearly allows exemption only for investment in a single residential house, as reinforced by the 2014 amendment to the Income Tax Act mentioned in recent judgments.

In such a case, the assessee may need to file an updated return under Section 139(8A) to rectify the claim. This would be required to reverse the exemption claimed and pay the applicable taxes with interest.

4. If treated as a single property, what should be the rate of tax payable in respect of the exemption claimed under Section 54F, viz. 10%, 20%, or 12.5%?

The rate of tax applicable on the long-term capital gains arising from the transfer of the property would depend on the provisions of Section 112A, which stipulates a tax rate of 10% for long-term capital gains on listed equity shares or mutual funds. If the property is treated as a single residential property and the gain is calculated upon sale, the applicable rate would be 10% as per the provisions of Section 112A.

Regarding the applicable tax rate if the exemption is considered valid but later revoked (which is not applicable in this case as the 3-year period is complete): the capital gain would revert to its original character. Since these were gains from listed equity mutual funds originally subject to Section 112A, the applicable rate would be 10% as originally applicable under Section 112A.

However, the tax rate applicable would depend on the specific provisions of the Income Tax Act, 1961, in force during FY 25-26, including any amendments or changes to tax rates. As of the last update in the source, the tax rate on long-term capital gains (LTCG) from the transfer of residential property, after claiming exemption under Section 54F, would generally be 20% plus applicable cess and surcharge. This is subject to change, and the actual tax rate in FY 25-26 would depend on the tax laws in effect at that time.

If the exemption under Section 54F is revoked, the gains may be taxed at 10% under Section 112A for listed equity mutual funds.

5. As possession is not taken by the assessee, can it be termed as a transfer of right in the property (under construction property), and would the gain be termed as long-term capital gains?

Based on the principles established in M/S D. N. SINGH THROUGH PARTNER DUDHESHWAR NATH SINGH v. COMMISSIONER OF INCOME TAX (Supreme Court Of India, 2023), the right to possession and the ability to realize income from the property can still constitute a transfer of rights. If the property is under construction and the assessee has made full payment, the gain can still be classified as long-term capital gains, provided the holding period exceeds the required duration as stipulated under the Income Tax Act.

When full payment is made but possession is not taken, the sale would likely be considered a transfer of "rights in the property" rather than the property itself.

For determining whether it qualifies as a long-term capital gain, the holding period is crucial. For immovable property rights, a holding period exceeding 24 months classifies the gain as long-term. Since the assessee acquired the rights in April 2021 and plans to sell in April 2025 (approximately 48 months later), the gain would qualify as long-term capital gain.

Under Section 2(47) of the Income Tax Act, transfer includes relinquishment of rights, which would qualify as a taxable event. The gains from such a transfer would typically be classified as long-term capital gains (LTCG) if the asset is held for more than 24 months.