Selling a Property and Buying an Under-Construction Apartment: Why Timing Is Critical for Capital Gains Tax Exemption

Introduction

Reinvesting proceeds from the sale of a residential property into another home is a common tax-planning strategy in India. However, when such reinvestment is made in an under-construction property, delays in completion can severely jeopardise the Long-Term Capital Gains (LTCG) exemption available under the Income Tax Act, 1961. The law adopts a strict, time-bound approach, and courts have consistently emphasised compliance with statutory timelines.

This article examines the statutory framework, constitutional principles, and judicial precedents governing LTCG exemptions in cases involving under-construction residential properties.

Statutory Framework Governing Capital Gains Exemption

Section 54 of the Income Tax Act, 1961

Section 54 provides exemption from long-term capital gains arising from the sale of a residential house property, subject to reinvestment in another residential house.

Key statutory conditions:

  • The assessee must purchase:

    • A residential house within one year before or two years after the date of transfer; or

    • Construct a residential house within three years from the date of transfer.

  • The exemption is proportionate to the amount reinvested.

  • Unutilised capital gains must be deposited in the Capital Gains Account Scheme (CGAS) before the due date of filing the return.

Failure to meet the construction timeline results in withdrawal of exemption.

Section 54F (Where Original Asset Is Not a Residential House)

Section 54F applies when the original asset sold is not a residential house, but the reinvestment is made in a residential property.

Key distinction:

  • The assessee must not own more than one residential house (other than the new one) on the date of transfer.

The construction timeline of three years remains mandatory.

Section 54EC as an Alternative Safeguard

Section 54EC allows exemption up to ₹50 lakh if capital gains are invested within six months in notified bonds such as:

  • National Highways Authority of India (NHAI)

  • Rural Electrification Corporation (REC)

This provision is often used as a risk-mitigation tool when construction delays are anticipated.

Importance of the Scheduled Completion Date in Agreements

Legal Significance of the Completion Timeline

Courts and tax authorities attach decisive importance to the scheduled completion date mentioned in the builder-buyer agreement, not merely the actual date of possession.

If the agreement itself specifies a completion date beyond three years from the date of sale, the exemption under Section 54 becomes legally vulnerable, irrespective of the buyer’s intent.

Impact of RERA Registration

While the Real Estate (Regulation and Development) Act, 2016 (RERA) mandates developers to disclose completion timelines, RERA compliance does not override the Income Tax Act.

RERA extensions granted to developers do not automatically extend the statutory period under Section 54.

Judicial Precedents on Under-Construction Properties and Section 54

Beneficial Interpretation in Genuine Delay Cases

Courts have, in certain cases, adopted a liberal interpretation where:

  • The assessee made substantial investment within time.

  • Delay was entirely attributable to the developer.

  • The assessee demonstrated bona fide intent.

CIT v. Sambandam Udaykumar (2012) 345 ITR 389 (Karnataka HC)

The Court held that completion of construction within three years is not mandatory if substantial investment is made and delay is beyond the assessee’s control.

Strict Interpretation Where Agreement Itself Exceeds Timeline

However, courts have also taken a strict view where statutory timelines are breached ab initio.

Prakash v. ITO (2008) 173 Taxman 311 (Bombay HC)

The Court ruled that statutory conditions under Section 54 must be strictly complied with, and equity cannot override clear legislative mandates.

Completion Certificate as Decisive Evidence

ACIT v. Smt. Sunder Kaur Sujan Singh Gadh (ITAT Mumbai)

The Tribunal held that Completion Certificate is the most reliable proof for determining compliance with the three-year construction condition.

Mere payment schedules or possession letters are insufficient in disputed cases.

Constitutional Basis of Capital Gains Taxation

Article 265 of the Constitution of India

Article 265 mandates that no tax shall be levied or collected except by authority of law. Capital gains tax, including exemptions and conditions, is a matter of strict statutory interpretation.

Tax exemptions are not fundamental rights but legislative concessions, and therefore must be claimed strictly in accordance with the law.

Principle of Strict Construction of Tax Exemptions

Courts have repeatedly held that:

  • Charging provisions may be interpreted liberally.

  • Exemption provisions must be strictly construed.

This principle directly affects Section 54 and Section 54F claims involving delayed construction.

Risk-Mitigation Strategies for Taxpayers

Use of Capital Gains Account Scheme (CGAS)

Depositing unutilised capital gains in CGAS demonstrates:

  • Bona fide intention to comply with Section 54.

  • Compliance with procedural requirements.

Failure to deposit funds can independently lead to denial of exemption.

Diversification into Section 54EC Bonds

Investing part of the gains in Section 54EC bonds acts as a statutory hedge against:

  • Construction delays

  • Litigation risk

  • Interpretation disputes with tax authorities

Purchase of Ready-to-Move Property

If construction delays become apparent early, purchasing a ready-to-move-in property within two years may preserve exemption eligibility, subject to ownership conditions.

Documentation and Evidentiary Requirements

Mandatory Documents to Retain

Taxpayers must preserve:

  • Registered sale deed of original property

  • Builder-buyer agreement

  • Completion Certificate or Occupancy Certificate

  • CGAS passbook and bank statements

  • Possession letter

Supplementary Evidence in Case of Delay

Where formal certificates are delayed:

  • Electricity or water bills

  • Property tax receipts

  • Valuation reports
    may support the claim, though they are secondary evidence.

Conclusion

Reinvesting capital gains in an under-construction property is legally permissible, but fraught with timeline-related risks. The Income Tax Act adopts a strict statutory framework, and courts balance taxpayer intent with legislative discipline.

Careful scrutiny of completion dates, proactive use of Section 54EC bonds, strict adherence to CGAS requirements, and meticulous documentation are essential to preserve long-term capital gains exemptions.

Tax planning in real estate is not merely about reinvestment—it is about timing, compliance, and legal foresight.

Location: Pune, Maharashtra, India

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