It might surprise you that income-tax laws that apply to a fully constructed residential house, might not apply to the sale of an under-construction house. An under-construction property is still a capital asset for income tax purposes. However, for specific provisions, it should not be treated as land or building.
When the computation of capital gain is in question, one must identify whether the asset in question is a capital asset or not. Once this aspect is figured out, one should move to identify its nature, period of holding, exemption and tax rates.
Let’s consider each aspect of taxation in case of a transfer/sale of an under-construction property.
Under construction house -A capital asset?
“Capital asset” means a property of any kind held by an assessee, whether or not connected with his business or profession, except those expressly excluded. The term “property” is a word of the widest amplitude, as the income-tax definition has re-emphasised this by using the words “of any kind”. The expression property is indicative and descriptive of every possible interest a person can have. Thus, any right which can be called a property will be included in the definition of “capital assets“.
When you book a house in an under-construction property, you get the right to buy that house. Until the house comes into existence, the buyer merely has the right to buy the house. When the construction is completed, you shall be entitled to the possession of the house by exercising your right to buy. Thus, the right to buy is a capital asset.
Nature of capital asset and period of holding
When you sell the right in an under-construction property, the capital asset “right to acquire a house” is being sold in that under-construction property and not the land or building per se. This distinction is essential because the relaxation given by the Income-tax Act to compute the period of holding of land or building does not apply to the under-construction house.
The period of holding an asset is essential to determine if the capital gain arising from the sale of a capital asset is long-term or short-term. Such classification is done because the long-term capital gain is taxable at a concessional rate after indexation of the cost of acquisition. In contrast, the short-term capital gain is typically taxable at the tax rate applicable to a person.
Generally, if the capital asset is held for more than 36 months, it is considered a long-term capital asset; otherwise, it is a short-term capital asset. A land or building is treated as a long-term capital asset if held for more than 24 months.
Since the under-construction house is neither land nor a building, the period of holding is 36 months or more to qualify as a long-term capital asset. In other words, if the booking right in an under-construction house is not held at least 36 months before the sale, the resultant gains shall be taxable as a short-term capital gain.
Income tax rate
Short-term capital gain from selling an under-construction house is taxable at the applicable income tax slab rates. The long-term capital gains, after claiming the exemption under Section 54F, if any, shall be taxable at 20% with indexation benefit.
Indexation benefits for long-term capital asset
If a long-term capital asset is transferred, the indexation is allowed for the cost of acquisition while computing the capital gains. The indexation of cost allows a higher deduction of the cost of acquisition to neutralise the effect of inflation.
Indeed, when the under-construction house qualifies as a long-term capital asset, the benefit of indexation shall be available. All the payments made to acquire the booking right of the house shall be considered as the cost of acquisition and will be indexed, taking the year of obtaining the right as a base.
However, the indexation benefit shall be available as per the payment schedule. The High Court, in the case of Nirmal Kumar Seth v. CIT  (Allahabad), has held that the long-term capital gain has to be calculated taking into account the indexed cost of acquisition as per the payment schedule.
Exemption from capital gain
Various provisions under the Income-tax Act provide an exemption from the capital gain arising from the sale of a long-term capital asset. For an under-construction house, one can only claim the exemption available under Section 54F when the nature of gains is long-term capital gains.
The section 54F exemption is allowed if net sale amount received is invested in one residential house property situated in India within the prescribed time. It is to be noted that the exemption under sections 54 and 54EC shall not be available because these two provisions require that the long-term capital gains should arise from the sale of immovable property, being land or building.
Withdrawal of old deduction or exemption
If you are planning to sell your under-construction house, remember there may be some benefits which shall be forfeited with retrospective effect.
If you have purchased such a house on loan, then the benefit of the pre-construction period interest would no longer be available. You need to forego the deduction of any interest paid during the construction period, which otherwise you would have claimed after completion of the house.
If the cost of the under-construction house has been claimed as an exemption under sections 54 or 54F, the exemption so claimed has to be reduced from the cost of acquisition of such under-construction property.
Section 80C allows a deduction of up to Rs 1.5 lakh for the repayment made of a housing loan even for an under-construction property. If you have claimed a deduction under section 80C, and the house property is transferred before the completion of 5 years from the end of the financial year in which possession is obtained, the deduction allowed earlier shall be treated as income of the individual for the year in which property is transferred.
(CA Naveen Wadhwa, DGM, R&D, Taxmann. CA Ridhima Bhatia, Senior Manager, R&D, Taxmann)