Section 86: capital gains exemption on investing in a residential house

Introduction

Section 86 applies when an individual or HUF transfers a long-term capital asset other than a residential house and invests the net consideration in a residential house in India. Relief is proportionate if only part of the net consideration is reinvested.

Key takeaways

The basic exemption

If an individual or HUF has capital gains from transferring any long-term capital asset that is not a residential house (the "original asset"), and within one year before or two years after the transfer purchases - or within three years after the transfer constructs - one residential house in India (the "new asset"), the gains are treated as follows: if the net consideration from the original asset exceeds the cost of the new asset, only a proportionate part of the gains is not charged to tax (in the same proportion that the cost of the new asset bears to the net consideration); if the net consideration is equal to or less than the cost of the new asset, none of the gains are charged to tax.

Depositing unutilised money before the return due date

If the net consideration is not used to buy the new house within one year before the transfer date, or is not used for purchase/construction before the taxpayer files their return under Section 263, the unutilised amount must be deposited in a specified bank or institution under a Central Government-notified scheme. This deposit must be made before filing the return, and no later than the return's due date, with proof of deposit submitted along with the return. The amount already spent, plus the amount deposited, is together treated as the cost of the new asset.

If the deposited amount is not fully used for the new house within the time limits, the unutilised portion (proportionate to the gains it represents) is charged to tax as income of the tax year in which three years from the date of transfer of the original asset expires, though the taxpayer may withdraw the unutilised amount as per the notified scheme.

When the exemption does not apply

The exemption under sub-section (1) is denied if the taxpayer, on the date of transfer of the original asset, already owns more than one residential house other than the new asset, or purchases another residential house (other than the new asset) within one year of the transfer, or constructs another residential house (other than the new asset) within three years of the transfer - and income from that other house is chargeable under "Income from house property".

What happens on a later purchase, construction, or sale of the new house

If, after claiming the exemption, the taxpayer purchases another house-property-taxable residential house within two years, or constructs one within three years, of the original transfer (other than the new asset itself), the capital gains earlier not charged to tax become chargeable as long-term capital gains in the year that other house is purchased or constructed.

Similarly, if the new asset itself is transferred within three years of its purchase or construction, the capital gains earlier not charged to tax become chargeable as long-term capital gains in the tax year of that transfer.

The ₹10 crore ceiling

If the cost of the new asset exceeds ₹10 crore, the amount above ₹10 crore is ignored for computing the exemption. Likewise, if the net consideration from the original asset exceeds ₹10 crore, the amount above ₹10 crore is ignored for the purposes of the deposit-scheme calculation.

What "net consideration" means

"Net consideration" means the full value of consideration received or accruing from the transfer of the original asset, reduced by any expenditure incurred wholly and exclusively in connection with that transfer.

Step-by-step flow for applying Section 86

1. 1

   Is the assessee an individual or HUF with capital gains from a long-term capital asset other than a residential house?

   • No: Section 86 does not apply.
   • Yes: Go to the next step.
2. 2

   Does the house-ownership bar in Section 86(5) apply?

   Relief is denied if, on the transfer date, more than one residential house (other than the new asset) is owned, or another house is purchased within one year or constructed within three years, with its income chargeable under 'Income from house property'.

   • Yes: No relief.
   • No: Go to the next step.
3. 3

   Was one residential house in India purchased within one year before or two years after the transfer, or constructed within three years?

   Unused net consideration must be deposited in the notified scheme before filing the return and by the due date under Section 263, with proof.

4. 4

   Compute relief

   Net consideration = full value of consideration less transfer expenses. If net consideration is more than the cost of the new asset, exempt gain = capital gain × cost of new asset ÷ net consideration; otherwise the whole gain is exempt. Cost above ₹10 crore is ignored.

5. 5

   Check later events

   Unused deposit triggers the X − Y charge when three years from the transfer expire; selling the new house within three years, or buying or constructing another taxable house within the stated periods, brings the relieved gain back to tax.

Practical checklist

Glossary

Net consideration

Transfer consideration reduced by expenditure wholly and exclusively connected with the transfer.

Proportionate relief

Capital gain relief scaled by replacement-house cost divided by net consideration.

Frequently asked questions