A taxpayer who sold a residential property for around ₹2.7 crore and reinvested the capital gains into seven adjacent flats on the same floor was initially denied exemption under Section 54 of the Income Tax Act, 1961, with the tax department arguing that the benefit applies only to investment in ‘one residential house.’
However, the tribunal ruled in the taxpayer’s favour, noting that the flats were contiguous and effectively used as a single residential unit. The ruling underscores a shift from a strict interpretation of ‘one house’ to a more practical, intent-based approach, where eligibility for tax exemption depends on actual usage, allowing multiple adjoining units to qualify if they function as one home.
Section 54 of the Income-tax Act allows taxpayers to claim an exemption from long-term capital gains tax arising from the sale of a residential house, provided the sale proceeds are reinvested in the purchase or construction of another residential property in India within the prescribed timelines.
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Multiple flats, single housing unit
The interpretation of Section 54 of the Income Tax Act, 1961, has shifted from a strict reading of ‘one house’ to a more practical approach. In cases where capital gains are reinvested in multiple adjacent flats, authorities are now focusing on how the property is actually used. If the units function as a single residential home, they may still qualify for tax exemption, reflecting a more intent-based and realistic view rather than a purely numerical one, say experts.
The expression ‘a residential house’ cannot be confined to a singular unit in a literal sense but must be understood in the context of a single residential establishment in substance.
“Where multiple contiguous flats are acquired and demonstrably integrated so as to constitute one composite dwelling, the exemption has been upheld, thereby recognising the commercial realities of modern urban housing configurations,” says Tushar Kumar, Advocate, Supreme Court of India.
The concept of ‘intent over number of units’ plays an important role in determining tax liability and, in turn, the investor’s post-tax returns. If a taxpayer can demonstrate a genuine intention to use multiple units as a single residence, the full capital gains may qualify for exemption under Section 54, helping preserve capital and improve reinvestment outcomes. Conversely, in the absence of such demonstrable intent, the Revenue may justifiably segregate the units, confining the exemption to a single flat and subjecting the balance gains to taxation: an outcome that can substantially erode returns and alter the financial viability of the transaction,” says Kumar.
There have been a number of pronouncements of the various high courts that have given a liberal interpretation to this beneficial provision.
“However, even after the amendment, while interpreting the post-amendment provision, which applies w.e.f. Asst. Year 2015-2016, most ITAT benches adopted the reasoning of the former High Court decisions and held that the amendment denies exemption in the case of multiple independent houses but does not prohibit combining adjoining flats into one residential house,” says Shobha Jagtiani, Partner, D.M. Harish & Co.
When multiple flats count as one
“Various ITAT benches have emphasised three key tests to determine whether an investment qualifies as the purchase or construction of ‘one residential house’, even if there is no single document covering the entire purchase,” says Jagtiani.
The first test is structural unity, whether the flats are adjacent or on the same floor, allowing them to be treated as a single structure. The second is functional use, whether two or more flats are actually used together as a single residence. The third test is actual modification, whether a common entrance or internal connections have been created, showing the intent to use the flats as one residential home with a single kitchen, drawing room, and living space.
Smart documentation, lower tax exposure
A prudent taxpayer would ensure contemporaneous documentation evidencing the intention and execution of a single residential unit comprising architectural plans, utility consolidation records, declarations of self-occupation, and consistent disclosures in income-tax filings.
“In high-value transactions, the issue is seldom one of legal principle but of proof; accordingly, the investment must be structured and documented in a manner that is inherently defensible across all appellate fora, thereby minimising the risk of protracted dispute with the tax authorities,” says Kumar.
Anagh Pal is a personal finance expert who writes on real estate, tax, insurance, mutual funds and other topics
