Selling property below market value can lead to litigation: How to avoid it

If you want to claim tax benefit by investing in a new house, use the market value to avoid litigation

When a property owner sells his house below market value, should he use the sale price or the market price when taking income tax benefit? With real estate prices in many markets across the country seeing a correction, cases, where the property is sold below market value, are on the rise. The taxpayer would want to use the sale price for computations. Tax officers, however, insist on considering the market value. 

Contention arises in two situations. One is when a taxpayer sells a house below market value and invests in a new one to claim benefit under Section 54 of the Income-Tax Act. Under this, when a taxpayer sells a house property, he can save tax by investing only the profit (capital gains) in another house. “In such situations, most tribunals have said that the value of the property should be calculated based on market price,” says Naveen Wadhwa, a chartered accountant with Taxmann.com.

There’s another provision – Section 54F – that allows taxpayers to save tax if they sell long-term capital assets (like land, commercial property, gold, stocks) and invest the entire proceeds in house property. Say, a property owner sells a piece of land below market value and wants to buy a house to save on capital gains tax. In this case, there are no clear rules whether he should consider the market value or sale value.

In a recent case, the ITAT allowed the taxpayer to consider the sale value of a plot and take the benefit under Section 54F. The judgment gives relief to taxpayers who would otherwise need to arrange extra funds to get the tax benefit. Say, a person sells a plot for Rs one crore, which has a market value of Rs 1.5 crore. If a tribunal rules that market value should be considered, the taxpayer would need to invest Rs 1.5 crore in a new house by arranging an additional Rs 50 lakh.

But chartered accounts warn that while the ITAT Kolkata bench ruled in favour of the assessee, there have been other tribunals that have held contrary views. The judgement of the ITAT is applicable only within their jurisdiction. If you are in a similar situation, refer to the judgments of the tribunal in your city. “If there is no precedence, then it depends on whether the assessee is willing to pursue the case or avoid litigation,” says Arvind Rao, a chartered accountant and founder of Arvind Rao & Associates. If the taxpayer doesn’t want to get into litigation, he can take the market value and accordingly claim benefit under Section 54F.

In the same case, the property owner had sold a plot and purchased another one. She also gave an advance to a developer for construction of a house. The tax officer objected and said that the taxpayer had bought a plot instead of a house as required under Section 54F. But the tribunal held that Section 54F allows the taxpayers to construct a house to get the tax benefit. The construction, however, has to be completed within three years from the date of selling the capital asset.