New Floor, New Rules? How Home Extensions Fit Into Capital Gains Exemptions

 

[Query 1]

I have read in your earlier issue of The Tax Talk that the tax on LTCG from sale of equity shares can be saved U/s 54F by investing the sale proceeds for purchase of another house property. Please guide whether additional or new construction on an existing house as first floor would also qualify for deduction u/s 54 F? 

Opinion:

With the change in time and family dynamics, a lot of taxpayers may be thinking of adding a floor to the house and saving on taxes? It sounds like a win-win, but does the taxman agree? Let’s find out.

Under Section 54F, you can save LTCG tax by reinvesting the net sale proceeds into a new residential property. You have two options:

1. Buy a new property – either one year before or two years after selling your assets.

2. Build one – within three years of the sale.

Key Considerations for Claiming Exemption
To unlock the Section 54F benefits, here’s what taxpayers need to know:

1. Eligibility hinges on “New.”:
Law very explicitly & clearly provides exemption only against purchase or construction of the new property. The taxman isn’t impressed by a new coat of paint or a fancy new doorbell—it has to be a whole new property.

2. Proportionate Exemption:
If your construction cost is less than the net sale consideration, the exemption applies proportionately. Spend big to save big. Half measures don’t get full tax perks!

3. Limit on Ownership:
The exemption is available only if the taxpayer is not owning more than one house property on the date of capital gain.

What about Extensions?

One of the important questions raised by you is whether exemption would be admissible on extension of the existing house property? In strict terms, construction of an additional floor on the same house may not fulfill the requirement of purchasing or constructing a new house. The law often sticks to plain language—if it says ‘new property,’ it means exactly that. As such construction of an additional floor on an existing property may not qualify for exemption u/s 54 or 54F, as these sections require the sale proceeds to be reinvested in another property.

However, in my considered view, the answer would depend upon the nature & character of extension of the house property you intend to carry out. If by way of extension you wish to have an altogether new dwelling unit then exemption may be admissible. However, if the extension is merely some addition to an existing house like addition of hall or rooms to the existing house then exemption may be outside the scope of section 54F.

Court Cases: A Mixed Verdict:

1. Chennai ITAT in Smt. Kethsial Justin vs. ITO, ITA No. 781/Chny/ 2018, taxpayer had put up a new dwelling unit on the first floor of an existing residential house and claimed exemption towards the cost incurred for construction. The Income Tax Officer denied the exemption for the simple reason that it was not a new house & relied on Madras High Court in CIT vs. V. Pradeep Kumar vs. CIT ( (2007) 290 ITR 90 (Mad) & Kerala HC in the case of Pushpa vs. ITO (2012) 79 DTR (Ker) 218.

ITAT noted that in the case of Pradeep Kumar, there was no tangible material to form a belief that a new dwelling unit was constructed. In this case, it was found that it was only an extension of the existing building by 382 sq.ft, that too after demolishing an existing ACC roofed out-house. It further discussed the judgement of Kerala HC in Pushpa vs. ITO (2012) 79 DTR (Ker) 218 & observed that in the said case, taxpayer had only extended the first floor construction; meaning no new dwelling unit was constructed.
In such factual circumstances, Madras HC held that taxpayers couldn’t claim deduction. Distinguishing this fact, ITAT Chennai allowed exemption towards extension of the house property

ITAT Chennai in above case gave weightage to the separate stair-case for the construction done in the first floor, approved plan showing separate kitchen for the first floor, separate water connection, separate electricity connection, etc. In such circumstances, the Tribunal held that the construction of a new residential house to its existing residence qualifies for deduction u/s 54F of the Act and allowed the deduction.

2. Kerala HC in Mrs. Meera Jacob Vs. ITO (2009) 313 ITR 411 (Ker) has made a passing remark while interpreting the provision of section 54F wherein the issue was also with regard to investment in modification /Expansion of an existing residential house. Lower courts/ authorities have held that exemption is available only when the investment is in the construction of a house and not for investment in modification or renovation. In this case, the taxpayer has only made addition to the plinth area which is in the form of modification of an existing house & so it was held that the assessee is not entitled to deduction claimed under s. 54F of the Act.

Kerala HC has unequivocally mentioned that “Even addition of a floor of a self-contained type to the existing house would have qualified for exemption”.

 

In these cases, courts generally favor exemptions if the new construction is independent enough to be considered a separate dwelling unit.

 

Key Evidence to Strengthen Your Case:
Considering the above provision of law and court ruling, if you are setting up an independent dwelling unit by way of extension of an existing house, you may be eligible for capital gain exemption. Arm yourself with evidence:

• Approved building plans showcasing an independent unit.
• Utility bills for separate electricity and water connections.
• Property tax receipts showing an increase post-construction.
• Photographs of the new floor.
• Separate entry—a new staircase often seals the deal.

 

The Bottom Line:
If your new floor is independent enough to look like its own home, you’re in luck. If not, consider it just another renovation – without any tax perks. In tax matters, independence isn’t just for teenagers; your floor needs it too!

[Views expressed are the personal view of the author. Readers are advised to seek professional advice before taking any decisions. Readers may forward their feedback & queries at nareshjakhotia@gmail.com.  Other articles & responses to queries are available at www.theTAXtalk.com].