Turning capital gains into your dream home by leveraging the power of gifting

So, what do you do if you already have two residential properties in your name but wish to buy a third one for your child or parents with the sale proceeds of another asset? Transferring one of the residential properties or non-residential assets to your family may help in some cases. 

Let’s take this hypothetical case: Ashish, who is married to Anita and has one adult daughter and senior citizen parents, owns two apartments in the same residential complex. He wants to sell the land he owns and some shares to buy another flat for his daughter. What are his options to qualify for tax exemption under section 54F?

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Scenario 1: Ashish transfers one of the apartments to his wife through a gift deed

On making this transfer, Ashish is left with one apartment in his name, which, as per the Income Tax Act, makes him eligible to claim exemption under 54F. However, professionals warn that such transactions are highly litigative.

Sujit Bangar, founder, Taxbuddy.com, explained: “Since the original owner (Ashish) entirely paid to buy the residential property, they will still have beneficial ownership of that property. This is the reason clubbing provision also applies to income arising from gifts given to spouses. So, the claim of 54F exemption will most likely be rejected.”  

The tax laws don’t forbid such transfers but these are highly likely to be picked up for scrutiny by tax officers. Courts have given mixed judgments in such cases where an old property was transferred to the spouse to reduce the number of properties in the first owner’s name, said Bengaluru-based chartered accountant Prakash Hegde. 

“In 2021, the High Court of Karnataka had ruled in the favour of the taxpayer allowing him to claim exemption under section 54F. The court observed that the law determines eligibility as per the number of houses ‘owned’, which is the only factor that should matter. But, in an order from a Hyderabad tribunal involving a similar case, the taxpayer was denied exemption terming the transaction a “colourable” device done solely for the purpose of tax saving,” Hegde said.

“The purpose of 54F is to help a taxpayer buy a house by giving him tax incentives. In such cases, the general view of the courts is that the purpose of the law is getting defeated so the exemption shouldn’t be allowed,” he added. 

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Scenario 2: Ashish gifts an apartment to senior parents or adult daughter 

This leaves Ashish with one property in his name and may not be seen as a way to avoid tax by the IT department, said Karan Batra, founder, Charteredclub.

“In the case of a parent or major child, the first owner is not indirectly controlling the property, unlike when you transfer to spouse. In a way, you are relinquishing your right over the property, so the tax department may not see it as a tax-saving workaround.”

Transferring a property to parents or major children also doesn’t attract clubbing provision, which means any rental income or capital gains from the sale of such property is taxed as part of the new owner’s income. 

However, it should be noted that in transferring property to either parents or an adult child, other members of the family get entitled to a share in that property as per the succession laws. For instance, if the parent dies intestate, their other children and surviving spouse also become legal heirs. “The taxpayer should be careful to not lose the property in just trying to save tax,” said Hegde.

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Scenario 3: Ashish transfers partial ownership of one apartment to adult daughter and spouse

In this case, since Ashish will be a part owner, it will be counted as a second property. “Ashish owns the first house and has 1/3rd ownership of the second house. Thus, he owns more than one residential house and will not be eligible,” said Bangar. 

Scenario 4: Ashish gifts land and shares to daughter

The daughter can sell these assets and use the gains to buy a residential property for herself. This way she can claim the exemption under section 54F. “This is a foolproof way to save tax when the first owner has more than one house. It is better to transfer the assets whose gains are to be used to buy a house, instead of transferring one of the houses to a family member,” said Batra. “The stamp duty on gifting MFs and shares is also lower than transferring residential property.” 

It should be noted that only mutual funds held in a demat account can be gifted. 

 Scenario 5: Ashish sells the shares and land and uses the gains to buy a property directly in daughter’s name

The law on Section 54F says that to qualify for exemption, the person selling the assets should not own more than one house. This means whether Ashish buys the new house for himself or someone else has no bearing on his eligibility. What matters is the number of houses he owns at the time of selling the assets. Buying a house directly in his daughter’s name will not qualify him for 54F benefit. 

Scenario 6: Ashish sells the land and reinvests the sale proceeds in bonds

Under section 54 EC, taxpayers can get tax exemption on capital gains made from real estate property, including land, by reinvesting the gains in specific government bonds. Ashish can use this option to get tax benefit on gains made from selling the land as he’s not eligible for 54F without having to transfer any of his assets to a family member. Gains from shares will not be exempt under this. 

Annual interest arising from the bonds will be taxed as Ashish’s income and the bonds are locked in for five years.

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Important points to note

Gifting assets to families attracts stamp duty, which can be steep in the case of real estate properties. While some cities like Bengaluru, Noida and Mumbai have concessional stamp duties of up to ₹10,000 for gift sale deeds made to close relatives, Delhi and Gurgaon attract the regular 4-7% rate. The property owner should be careful that the stamp duty doesn’t set off the tax saving. 

Moreover, since there is a risk of the case being picked up for scrutiny by the tax department, there could be additional litigation costs. “In transfers made to spouses, the chances are especially high. If the gains are a few lakhs, the risk may not be worth the money, time and mental peace you will end up sacrificing in litigation that can go on for several years,” said Hegde.  

High net worth individuals (HNIs) should note that under the General Anti Avoidance Regulation (GAAR) provisions in the IT Act, the tax department automatically disregards such transfers made through gift deeds right before selling assets to get 54F exemption where the tax benefit is ₹3 crore or above. “When a taxpayer transfers a property to a family member to reduce the number of houses in their own name and the tax benefit being claimed under 54F exemption is at least ₹3 crore, the gift deed is automatically ignored,” said Hegde. “GAAR provision was included in the IT Act in 2017 to clamp down on such workarounds.”

Chartered accountants advise that 54F exemption planning should be done much in advance to avoid litigation. Instead of transferring properties right before selling other assets, purchase of a second property can be done directly in the family member’s name. “If you already have one property and plan to buy one more with the sale proceeds of other assets, buy the second property in spouse, child or parent’s name. By doing this, you keep the option of claiming benefit on a third purchase in the future open,” said Batra. 

The law doesn’t say in whose name the new house should be bought to claim 54F exemption, so buying a property in a family member’s name makes you eligible for claiming the tax benefit.