Claim tax benefit for purchase and renovation

To save long-term capital gains tax liability arising due to theselling of a residential property, the seller can use the proceeds to buy or construct another house. This is clearly stated in Section 54 of the Income Tax (I-T) Act. What is not so clear is whether the amount spent towards carrying out alterations and modifications to the purchased property can also be claimed under the section. A recent ruling by the Mumbai Income Tax Tribunal indicates that this is permissible.

Contention on cost of improvement

In a recent case at the Mumbai Income Tax Tribunal, a taxpayer had sold a house for Rs 2 crore. At the time of computing capital gains for filing his income-tax returns, he claimed deduction under Section 54 of the I-T Act worth Rs 1.10 crore paid towards purchasing another house. Further, he had spent Rs 14.27 lakh towards making the new property habitable, as it was purchased in a dilapidated condition. He claimed this amount too under Section 54.

The tax officer disagreed with this claim and held that any expenditure incurred to improve the property will be allowed as cost of improvement, and should be claimed at the time when the property is sold. The I-T Act defines cost of improvement as any expenditure of a capital nature incurred by the tax payer to make additions or alterations to an asset.

The tax payer contended that soon after purchasing the property, he had to engage the services of an interior decorator, plumber, electrician, etc to make the house habitable, which resulted in the aforementioned expenditure. The tax officer held that the tax payer was claiming cost of improvement not at the time of sale of his property but at the time of claiming exemption on capital gains, and hence rejected the claim. The first appellate authority too did not favour the tax payer.

Purchase deed saves the taxpayer

At the Tribunal level, the tax officer argued that the expenditure incurred was meant to make the house comfortable. It thus qualifies as repairs and renovation, and most certainly cannot form part of the cost of acquiring the new property.

While deciding on the case, the Tribunal gave the opinion that Section 54 is actually an incentive provision. It should accordingly be interpreted in a liberal manner to grant benefits to taxpayers to fulfil the law's mandate, which is to promote investment in housing.

The Tribunal explained that the term 'house' should be understood as a property capable of being habitable. In this case, the purchase deed through which the tax payer purchased the new property clearly stipulated that the house required extensive civil, plumbing, electrical and painting works, which was to be borne solely by the purchaser. Readers should note that this clause is seldom used in purchase agreements, but proved to be a crucial deciding factor during the course of the appeal.

The Tribunal observed that there was no difference of opinion between the two parties about the work being done right after the purchase of the property and concluding within seven months of the date of purchase. The tax payer also possessed the necessary invoices to prove this.

It could thus be inferred that this expenditure was part of a continuing transaction that started with the purchase of the property in a dilapidated condition in July and concluded with the extensive construction work that began immediately after and concluded in January next year. As the work was started immediately, the Tribunal observed that it is equivalent to the meaning of construction of a house, as provided under Section 54 of the Act.

This section does not lay down any condition that if a tax payer purchases a new residential house, the benefits associated with the construction of this house cannot be extended simultaneously. As long as the conditions laid down under the section are complied with, the benefits of purchase and construction can co-exist. Similarly, the section does not impose any restrictions regarding what constitutes habitable to get the benefit of deduction under Section 54. The term 'habitable' has to be interpreted in the context of the socio-economic status and standing of the tax payer.

What is "habitable"?

The Tribunal held that if a tax payer is allowed to purchase or construct a residential house without any ceiling on the amount of investment under the said section, the tax payer should not be denied benefits under Section 54 if a purchase is followed up with alterations, additions and modifications. This liberal interpretation can, however, definitely not be extended towards the purchase or installation of items of comfort, such as air-conditioners, consumer electronics, entertainment equipment, electrical and other equipment, furniture, etc.

This interpretation of the Tribunal attempts to suggest that taxpayers can purchase a residential house with one floor and later construct two more floors on it and claim benefit under Section 54 for expenditure incurred on both.

The writer is a chartered accountant and financial planner

  • If you sell a residential property after three years of purchase, you can get tax exemption on long-term capital gains

  • This can be availed by reinvesting the capital gains in buying another residential house one year before or two years after transfer or sale of first property

  • The benefit can also be availed if the capital gains is spent on construction of a residential property

  • If you buy a second house and spend a considerable amount on making it "habitable", the amount spent can be claimed as deduction under Section 54

  • Income Tax tribunal says Section 54 is meant to promote house ownership and therefore benefit of purchase and construction can co-exist

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