Can you claim Section 54 tax exemption for buying two residential flats? Here's what the ITAT ruling says

Can you claim tax exemption under Section 54 if the investment involves two flats? A recent Mumbai Income Tax Appellate Tribunal (ITAT) ruling has provided clarity on this question.

The Tribunal held that two adjacent flats legally and physically amalgamated into a single residential unit could be treated as one residential house for claiming capital gains exemptions, as reported by TaxGuru.

What was the case?

The taxpayer sold a residential property at Malabar Hill, Mumbai, for ₹43 crore. After considering the cost of acquisition, he computed long-term capital gains of ₹26.59 crore and claimed the entire amount as exempt under Section 54 for Assessment Year 2021-22.

The investment involved Flat Nos. 3101 and 3102 at Lower Parel, Worli.

Section 54 provides relief from long-term capital gains arising from the sale of a residential property when the gains are reinvested in another residential house.

Why did the tax officer reject part of the claim?

According to the TaxGuru report, the assessing officer (AO) treated the two flats as separate properties. He allowed the Section 54 exemption only for the ₹22.56 crore investment in Flat No. 3102 and taxed the remaining ₹4.03 crore of capital gains.

The issue was particularly relevant because, from AY 2021-22, Section 54 permits investment in two residential houses only where the capital gain does not exceed ₹2 crore.

Since the taxpayer's capital gain was ₹26.59 crore, the tax department argued that the benefit could not extend to two separate houses.

Why did the ITAT treat the flats as one house?

The taxpayer subsequently entered into a registered supplementary agreement dated 25 March 2022 with the developer to amalgamate the two adjacent flats.

After the amalgamation, Flat No. 3101 lost its separate identity, and the composite property continued as Flat No. 3102.

Why did ITAT allow the Section 54 exemption?

The Mumbai ITAT agreed with the CIT(A) that the two flats had effectively become one residential unit. Therefore, the restriction concerning investment in two separate houses was not applicable.

The Tribunal also upheld the admission of the supplementary agreement and bank statements.

The ITAT upheld the ₹26.59 crore Section 54 exemption and dismissed the Revenue's appeal. The order was pronounced on 17 August 2026, as reported by TaxGuru.

What is the latest Section 54 rule?

Section 54 allows an individual or HUF to claim exemption on long-term capital gains (LTCG) from the sale of a residential house by investing in another residential house in India.

To qualify for exemption, the original property must be held for more than 24 months to qualify as long-term. If sold within 24 months, it is a short-term capital asset and Section 54 exemption is not available.

The new house must be purchased within one year before or two years after the sale. From AY 2021-22, a one-time option was introduced to invest in two residential houses in India where the LTCG does not exceed ₹2 crore. This option can be exercised only once in a taxpayer's lifetime.

The Mumbai ITAT ruling does not remove this limit. Instead, it clarifies that where two adjacent flats are legally and physically amalgamated into one residential unit, they can be treated as one house rather than two separate houses.

However, from AY 2024-25, the Finance Act, 2023 capped the investment considered for Section 54 exemption at ₹10 crore. Any amount invested above ₹10 crore is not considered for calculating the exemption.

Disclaimer: This is only for informational and educational purposes. Please consult a qualified expert for the latest laws and regulations.