To deal with the topic let us consider the following fact situation:
1) As assessee has sold a house property and earned some capital gain;
2) The realised consideration, instead of investing in buying another house, was utilised for another purpose, say, for investment in mutual funds;
3) To avail the exemption under Section 54/54F, assessee took housing loan from bank and bought one residential house property within stipulated time;
4) Now at the time of filing return, assessee took deduction under Section 24 in respect of interest paid to the bank in respect of housing loan and exemption under Section 54/54F as well.
Ordinarily to derive benefit of exemption u/s 54/54F it is desirable that the proceeds of sale or consideration from sale of long term capital asset is to be utilised for purchase of house property. But in the given fact situation the assessee utilises the consideration for investment in mutual funds.
In the second course the assessee go on to borrow money and utilise the loan amount for purchase of house property. In this situation the assessee tends to claim the following reliefs under the provisions of the Income tax Act:
(a) Claim for deduction of interest u/s 24(b) viz. a viz interest on borrowed capitals;
(b) Claim for exemption u/s 54/54F viz a viz amount invested in purchase of residential property.
The main ingredients to compute the exemption allowable under s. 54/54F vide Bangalore bench decision in Shri Gouli Mahadevappa v. Income-tax Officer, Ward-2, Hospet (2011) 128ITD503 are:-
(1) the "capital gain" arising from the transfer of any long-term capital asset,
(2) the net consideration in respect of the original asset,
(3) the extent of the net consideration invested in the new asset.
The words ‘extent of the net consideration’ is indicative of the outer cap for exemption. Sub-section (1) of s. 54 further provides following liberties to the assessee in the availment of exemption on profit on sale of property used for residence:
a) Either to purchase a property before one year from the date of transfer;
b) Or to effect purchase before two years after the date of sale of property;
c) Or to effect a construction within a period of three years from the sale of sale of property.
Thus the fact that the assessee has a statutory right to get exemption even if he has invested into purchase within one year before actual sale of property is an evidence enough to disprove the notion that the funds that are invested in the new property for availing exemption u/s 54/54F must be the ones that are realised from sale of property. In other words use of borrowed funds for purchase of property in the present sequence should not be an impediment for claim of exemption u/s 54/54F.
Further section 54 benefit is available in two steps:
Step 1) When the assessee invests the capital gains into house within statutory dates – s. 54(1);
Step 2) when the assessee deposits capital gains into capital gains account scheme and defer purchase- s. 54(2).
The sum total of exemption would be the amount invested as per step 1 and