How to Claim Capital Gain Tax Exemption on Redevelopment Projects?

Section 45 of the Income Tax Act, 1961, provides that any profits or gains arising from the transfer of a capital asset effected in the previous year will be chargeable to income tax under the head 'Capital Gains'. 

If the land or building or both have been held for less than 24 months, then short term capital gains will be attracted. 

If the land or building or both have been held for more than 24 months, then long term capital gains will be attracted.  

Long-Term Capital Gain in case of Redevelopment Project 

Section 2(47) of the Income Tax Act, 1961, contains an inclusive definition of the term ‘transfer’. Such a transfer attracts Capital Gains Tax. 

However, capital gains tax shall be attracted in the year of transfer by the person who has transferred such property. 

Further, as per section 45(5A) capital gains would be taxable for individuals and Hindu Undivided Family (HUF) who have entered into an agreement for the development of a project in the year where the designated authorities issue a certificate of completion for the whole or part of the project.

Exemptions available under section 54: 

Eligible assesses – Individual and Hindu Undivided Family (HUF) 

Conditions to fulfil- 

• There should be a transfer of residential house 
  It must be a long-term capital asset 
  Income from such house should be chargeable under ‘Income from House Property’
• Where the amount of capital gains exceeds ₹ 2 crore 

One residential house in India should be  

• Purchased within 1 year before or 2 years after the due date of transfer or 
• Constructed within a period of 3 years after the date of transfer. 

Where the amount of capital gains does not exceed ₹ 2 crore 

The assessee may- 

• Purchase  two residential houses in India within 1 year before or 2 years after the date of transfer or 
• Construct two residential houses in India within a period of 3 years after the date of transfer. 

Thus, when an assessee acquires a new flat within a period of 3 years from the surrender of the original flat, then the capital gains shall be exempted under section 54.

New flat pursuant to redevelopment project & timing of taxation: 

• In case of redevelopment, the new flat acquired will be normally treated as construction as per section 54. Here, the date of handing over of the flat pursuant to redevelopment and sale will be considered as the date of transfer. 
• The Income Tax Department has come to a conclusion that all redevelopment cases shall be considered as transfers and LTCG taxes will be levied if the possession period is beyond 3 years. 
• It is advised that the assessees insist on acquiring another property within 3 years from the date the assessee has vacated such old flat and handed over the same for redevelopment to claim deduction under section 54. 
• However, in the case of the allotment of a flat or a house by a cooperative society, which the assessee is a member of, it will be treated as construction of the house. 
• Further, the assessee is entitled to exemption even though the construction is not completed within the statutory time period. 
• In case, the builder delays possession of a new flat within 3 years, then the Assessing Officer at his discretion shall disallow the exemption under section 54. If the original owner acquires the new flat (with a bigger area) pursuant to the redevelopment agreement where such assessee has claimed exemption u/s. 54 is sold within a period of 3 years from the date of its purchase then the capital gain exemption claimed earlier would become taxable in the year the new flat is transferred. Here, exemption under section 54 can be claimed for the receipt of extra carpet area i.e., over and above the existing carpet area.  
• If the residential flat is held for a period of less than 3 years, then the receipt of extra area by the individual members would be taxable in the hands of the individual members. 

Conclusion

It is advisable to take suggestions from Tax Experts or Chartered Accountants regarding the development agreements so as to avail maximum exemption in case of capital gains arising out of redevelopment projects.