Capital Gains Tax Exemption Valid Even on Property Bought from Spouse, ITAT Mumbai Says

This case is related to a woman named Kavita Damani and her capital gains tax exemption under Section 54 of the Income Tax Act.

In March 2002, Kavita Damani and her husband, Manoj Damani, jointly purchased two adjacent flats in Powai, Mumbai. Therefore, both of them were the owners of 50% shares of each flat.

In April 2017, Manoj gifted his 50% share in these flats to his wife, Kavita, through a registered gift deed. After this point, Kavita becomes the full 100% share owner of these flats and the legal owner of the Powai flats.

Later, in January 2020, Kavita sold both the Powai flats for Rs. 5.98 crore and earned a long-term capital gain of Rs. 4.21 crore. Then, to save tax on this profit, in March 2021, she bought another flat in Lodha Estella worth Rs. 3.85 crore from her husband by using Section 54 of the Income Tax Act.

Section 54 of the Income Tax Act says that if someone sells a residential house and then reinvests the capital gains in buying some other property or residential house within the period of two years, then they can claim a capital gain tax exemption.

Additionally, Kavita paid Rs. 11.55 lakh in stamp duty, making the total investment for exemption Rs. 3.96 crore. However, when she went to file her ITR to claim exemption of Rs. 3.96 crore under Section 54, the Assessing Officer (AO) rejected her claim and served two objections on her claim:

• First, the initial Powai property was not actually owned by Kavita, and she was only a nominal owner. Hence, as per Section 64, the capital gains from the Powai flats should be taxed in the hands of her husband, not her.
• Second, the Assessing Officer (AO) said that the purchase of the Lodha flat from her husband was not a real transaction. He thought it was just a technique to avoid paying tax and not an honest purchase.

As a result, the AO added Rs. 3.96 crore back to her taxable income, meaning now she will have to pay tax on her capital gain.

Kavita then approached the Commissioner of Income Tax (CIT – Appeals); however, they also announced their decision in favour of the assessing officer and rejected her claim.

Then, Kavita approached the Mumbai Income Tax Appellate Tribunal (ITAT). The ITAT carefully reviewed all the documents and facts and ruled in favour of Kavita. Saying:

• The Tribunal said that after the gift deed in 2017, Kavita became the full legal owner of the Powai flats. This gift was valid under law.
• Additionally, all the rent income from these flats was being declared and taxed in her name. The sale proceeds of Rs. 5.98 crore were credited to her bank account. She filed her Income Tax Return (ITR) correctly, showing this income.

Therefore, it was confirmed that Kavita was the true owner and eligible to claim the capital gains.

The ITAT said that the purchase of the new flat from her husband was honest, and they listed four reasons for this:

• Kavita made the payment through bank transfer, which is traceable and proves real money was involved.
• A proper legal sale document was registered, indicating this was not a bogus deal.
• She bought the flat within the required time limit, i.e., two years of selling the Powai flats, which completely satisfies Section 54.
• She also deducted TDS from the payment and deposited it with the government, which proves it was treated as a real transaction.

Therefore, the Tribunal decided that even if the property was purchased from her husband, it doesn’t matter as long as all legal steps were followed. There is no rule under Section 54 that says you cannot buy from a relative.

This case clearly indicates that the Section 54 exemption is allowed even if the new property is bought from a relative, like a spouse, as long as the transaction is genuine, properly documented, and the payment is made through legal means.

The relationship between the buyer and seller does not affect the exemption if all tax and legal rules are followed. Also, even though stamp duty must be paid, it can be included as part of the cost of acquisition when calculating investment under Section 54. On the other hand, the seller (her husband) must pay capital gains tax if there is a profit on the sale, unless he uses exemptions.