For those who aren’t familiar, Section 54 allows individual taxpayers to claim a full tax exemption on long term capital gains (LTCG) from selling residential house property or land, provided they reinvest those gains into another residential property in India within a specified timeframe.
Dilip showed in the Section 54 calculations that he had incurred Rs 15.99 lakh as indexed (inflation adjustment) cost of improvement for the house he sold. However, he failed to provide any bank receipt of transactions or any ledger to prove the legitimacy of the transactions. All the payments were made in cash over several years. While he did present some documentary evidence in the form of contractor bills and work details, that was all he had. The income tax officer was still not convinced.
Additionally, the income tax officer pointed out that Dilip sold the house for Rs 41 lakh, even though its stamp duty value was Rs 67 lakh. The officer also pointed out that this property had five co-owners, including Dilip and his minor daughter, but he purchased the new residential property jointly in his wife’s name without mentioning a clear percentage share. Hence the officer said he was only willing to allow a tax exemption of 50% of the total investment amount, rather than the entire amount.
Accordingly, after considering the correct sale consideration under Section 50C and disallowing the cost of improvement, the tax officer computed that the total long-term capital gain (LTCG) was computed at Rs 15.99 lakh which was then added to Dilip’s total income. Dilip appealed against this order to the Commissioner of Appeals CIT(A). CIT (A) recalculated the total LTCG as Rs 9 lakh as against Rs 15.99 lakh computed by the tax officer and partially allowed his appeal. After that, Dilip took his case to the Income Tax Appellate Tribunal (ITAT) Ahmedabad.
At the ITAT Ahmedabad, Dilip won the case on August 25, 2025. ITAT Ahmedabad said that they are inclined to accept Dilip’s claims in principle and directed the tax officer to allow the claim for Section 54 upon verifying the actual contributions made by Dilip and his wife for the new property.
How did this case start?
According to the order of ITAT Ahmedabad dated August 28, 2025, here’s the timeline of events:
January 16, 2012: Dilip sold the residential house property for Rs 41 lakh (41,00,151) where he and five others including his minor daughter.
A.Y. 2012–13: Dilip did not file any ITR for this year.
2019: The tax officer initiated reassessment proceedings against him under Section 147 and accordingly, Dilip filed an ITR declaring total income as Rs 1,690 and claiming a long-term capital loss of Rs 8,70,727 after taking into account indexed cost of acquisition, cost of improvement, and after claiming exemption under section 54. He also included the share of capital gain arising to his minor daughter and claimed deductions accordingly.
ITAT Ahmedabad said this about his Section 54 LTCG tax exemption claim
ITAT Ahmedabad in its order dated August 25, 2025, said that Dilip has not made any request for referring the matter to the file of DVO at any stage of hearing.
ITAT Ahmedabad said: "However, with respect to the claim for exemption under Section 54, we are of the view that the Assessing Officer and Ld. CIT(A) have not adequately appreciated the assessee’s (Dilip) contention regarding the proportion of investment made in the new residential property."
ITAT Ahmedabad said that it is not in dispute that Dilip and his wife jointly purchased the new residential property. ITAT Ahmedabad noted that Dilip has however claimed that the investment was made in the ratio of 2:1, which was corresponding to their respective shares in the sale proceeds of the original property, which included the share of the minor daughter whose income is clubbed with that of the assessee.
The ITAT Ahmedabad also noted that Dilip has submitted that the investment in the new property was made entirely out of the sale proceeds of the old property and that an Affidavit from both the co-owners was also submitted thus confirming this ratio of 2:1.
ITAT Ahmedabad said: “In our view, the actual contribution towards the purchase of the new house is a relevant factor while determining the eligible exemption under Section 54. Therefore, we are inclined to accept the assessee’s (Dilip) claim in principle, subject to verification of the actual contributions made by the assessee and his wife towards the new property. Accordingly, we direct the Assessing Officer to verify the proportion of investment made by the assessee and allow the exemption under Section 54 accordingly."
ITAT Ahmedabad said this about house improvement expenditure incurred in cash
ITAT Ahmedabad said that with regard to Dilip's claim of indexed cost of improvement, they note that although he has submitted contractor bills and supporting documentation for the amount of expenditure claimed to have been incurred by him, the payment was made in cash and the same is not reflected in the bank account.
ITAT Ahmedabad said: "Considering the fact that the improvements were stated to have been carried out nearly two decades ago, we find merit in the assessee’s contention that expecting banking records or passbooks for such an old transaction may not be reasonable. Since the assessee has provided the best available documentary evidence in the form of contractor bills and work details, we are of the view that the claim for indexed cost of improvement may be allowed to the assessee, in the interests of justice."
Judgement: "In the result, the appeal of the assessee is partly allowed for statistical purposes, in terms of our above directions. This order is pronounced in Open Court on 25/08/2025.”
What did Section 54 say at the time of this judgement?
Chartered Accountant Suresh Surana explains:
- At the time of the judgment, Section 54(1) of the Income Tax Act, 1961 provided that if an individual or a Hindu Undivided Family (HUF) sold a long-term capital asset in the form of the residential house, the capital gains from such transfer would be exempt from tax, subject to reinvestment conditions.
The Section 54 tax exemption was available if the taxpayer:
- Purchased another residential house within one year before or two years after the date of transfer, or
- Constructed a residential house within 3 years after the date of transfer.
- If the amount of capital gain exceeded the cost of the new asset, the difference was taxable. Conversely, if the capital gain was equal to or less than the cost of the new asset, the entire gain was exempt.
- Further, under Section 54(2), any portion of the capital gain that was not utilized for purchase or construction of the new house before the due date of filing the ITR had to be deposited in a notified scheme of a specified bank or institution (CGAS). This deposit ensured that the taxpayer could still avail the exemption benefit.
Can you claim the cost of improvement if paid in cash?
Chartered Accountant (Dr.) Suresh Surana says that the Income Tax Act, 1961, does not impose any specific restriction on making payments in cash for expenses incurred towards the cost of improvement of house property.
Surana says: "However, claiming such expenses becomes challenging in practice, particularly when credible documentary evidence such as bank statements, invoices, or other payment proofs is not available. In the absence of proper substantiation, tax authorities are unlikely to accept the claim, as they generally expect payments to be supported by banking records or authentic bills."
What is the significance of this judgement for taxpayers?
ET Wealth Online has asked various experts about the significance of this judgement for taxpayers, here’s what they said:
Ashish Mehta, Partner at Khaitan & Co, says: From the facts as recorded by the Hon’ble ITAT (which is the final fact-finding authority), the taxpayer had submitted copies of contractor bills and supporting documents for having incurred costs on the improvements of the property. The taxpayer submitted that payments to the contractor were made in installments and that too more than two decades ago. Considering substantial lapse in time, the ITAT agreed that the taxpayer had submitted details that were available and could not be reasonably expected to retain banking records or passbooks for such an old period.
Chartered Accountant (Dr.) Suresh Surana, says: The significance of this case is that the ITAT allowed the claim of indexed cost of improvement despite payment in cash and absence of bank proof based on best available documentary evidence, acknowledging that expecting banking records for very old transactions (nearly two decades old) may be unreasonable. Additionally, the case also clarified that exemption under Section 54 should consider the actual ratio of investment made by co-owners, not just joint ownership on paper. This ensures that the exemption is allowed proportionate to the genuine contribution from the assessee. The judgement reflects a balanced approach, preventing undue hardship to taxpayers who maintain proper evidence but lack modern-day payment proofs for old transactions.
Mihir Tanna, associate director, S.K Patodia LLP says: “Court has considered genuine reasons for not maintaining banking records to support the claim. In the given case, taxpayers could provide bills for expenses incurred two decades ago.
Usually we suggest to clients to keep documents till the time the income tax department has power to issue notice.
Another issue discussed in the judgment is about share/ownership of property. There is a misconception in the minds of many taxpayers that share in the property is based on percentage specified in the agreement and in case the share is not mentioned in the agreement, ownership of property will be considered as 50:50. However, for income tax purposes, contribution given by each buyer at the time of acquisition is important. Accordingly, in the given case, the court has considered that while determining the eligibility of exemption under Section 54 of the Income Tax Act ratio of 2:1 (in which investment was made) has to be considered.
A similar stand should be considered in case the husband and wife jointly purchase a property and the entire consideration is paid by the husband only. The husband will be considered as 100% owner for income tax purpose.
