CGT - Investment for construction of flat - Income Tax

Sale of Vacant Land for funding the construction of apartments and Allotment of flat by beneficiary

Opinion sought regarding Capital Gain Tax and types of documents to be executed w.r.t. Income Tax, RERA & GST Act.

Facts / Background:

N purchased the property consisting of land and residential house in South Chennai measuring about 2600 sft in 1974 and 50 % share of the property was settled in favour of his wife L in 2015. N expired in 2019 leaving behind his wife L (77) and two sons K & P as legal heirs.

As the building is very old, L, K & P want to demolish the building and construct an apartment building with 3-4 flats. But they are not in a position to construct with own funds and are also not interested in a Joint Venture scheme of any builder due to variety of reasons.

R (73) – Brother of N has a vacant plot in West Chennai purchased in 1975. L and her two sons have approached R for funding the construction of the flats in their land with an offer to allot one flat with uds of land in return proportionate to the amount to be invested by R for the development & construction of flats.

It is assumed that - Since R will be utilizing the sale proceeds of the vacant land against the value of the flat to be allotted to him, there will be no capital gain tax for him. Similarly, since L and sons will be utilizing the sale proceeds of uds of land to R, by constructing flats for them, they also will be exempted from capital gain tax.

Now, with regard to execution of documents to complete the transactions one option is - L and sons have to execute a sale deed for the sale of uds of land to R and subsequently all the four have to enter into construction agreement with the builder for development & construction of flats to them.

Supposing if L and sons request for the money (sale value of R’s land)) to be paid directly to them in advance without involving the builder on the understanding that they will transfer one flat with uds for the value of investment after completion of the flats - will it be risky or alright to concede to the request.

What will be the implications of capital gain tax and the consequences if the flat is not completed by the builder as per the requirements?

Any other alternate and viable documentation to take care of Capital Gain Tax, Stamp Duty and other statutory requirement.

Hi Laxman,

This is a fairly complex transaction involving capital gains tax (CGT), RERA compliance, GST, and legal documentation. I’ll break down the key issues and possible approaches based on the facts you shared.

Key Points & Analysis:

1. Capital Gains Tax (CGT) Implications

Sale of vacant land by R (brother of N)
R plans to sell his vacant land to L and her sons (N’s family) for funding construction. You mentioned the assumption that since R is using sale proceeds to get a flat allotment, there will be no capital gains tax for R.

This is not entirely correct.
Capital gains tax liability arises on actual sale or transfer of land/property for consideration. Merely getting a flat in exchange (which is a different asset) will attract capital gains unless a specific exemption applies. No exemption under Income Tax allows capital gain exemption simply because sale proceeds are used for construction unless conditions under Section 54F or similar are satisfied.
L and sons’ sale of undivided share (UDS) in their land to R
This will attract capital gains tax, as they are transferring UDS in the land to R for consideration (sale proceeds). If they invest this consideration into construction of residential property within prescribed timelines, they may claim exemption under Section 54F (if the entire sale consideration is used for construction of residential house and the other conditions are met).
Sale Consideration vs. Capital Gain
The capital gain is calculated as sale consideration minus cost of acquisition and improvement. The cost of construction of flat (new asset) cannot be directly set off against capital gains from sale unless exemptions are claimed and conditions are satisfied.
If flats are allotted to R in lieu of construction cost, it may be considered as “transfer” under Income Tax, triggering tax implications.

2. RERA & GST Implications

Since flats are under construction, RERA registration will be applicable for the project.
GST will be applicable on construction services.
If the builder is involved, they will collect GST on construction services from L, sons, and R.

3. Legal/Documentation Options

Option A: Sale Deed + Construction Agreement
- L and sons execute sale deed of vacant land or UDS in favor of R for agreed consideration.
- All parties enter into a formal construction agreement with the builder (which should be registered and RERA compliant).
- R funds construction and gets flat(s) allotted proportionately.
This approach provides clear ownership transfer, tax clarity, and legal enforceability.
Option B: Payment directly to L and sons without builder involvement
- R pays consideration directly to L and sons.
- L and sons construct flats on their land.
- R is allotted a flat in lieu of investment after completion.
This is risky because:
- No formal agreement with builder ensures timely or quality construction.
- R may face difficulty in enforcing possession or allotment.
- Capital gains tax implications may get complicated as actual transfer and construction costs are not documented properly.
- Stamp duty and ownership documentation become complex.

4. Risks if Flats are Not Completed

Delay or non-completion can result in legal disputes.
R may lose investment or get delayed possession.
L and sons may face penalties under RERA or buyer claims.
Tax authorities may question the transactions and deny exemptions.

Recommendations & Alternatives:

Execute clear Sale Deed + Construction Agreement
This is the safest approach, ensuring compliance and clarity.
Section 54F Exemption for L & Sons
They can claim exemption on capital gains if entire sale proceeds invested in construction of flats within 3 years.
Stamp Duty and Ownership
Stamp duty will be applicable on sale deed and must be paid as per local laws.
Consider Joint Development Agreement (JDA)
Rather than outright sale, a JDA with builder or R where landowners get flat(s) proportionate to their contribution and builder funds construction may be a better alternative.
GST Compliance
Ensure GST registration and compliance by builder for construction services.

Summary

Scenario	Capital Gains Tax Impact	Legal Risk	Recommendation
Direct sale of land to R + Construction agreement with builder	CGT on sale. Exemption possible if reinvested under Sec 54F	Low (with documentation)	Preferred route
Payment directly to L & sons by R, without builder agreement	CGT on sale, risk of no clear ownership transfer of flat	High (risk of disputes)	Not recommended
Joint Development Agreement	No outright sale; share in constructed flats	Moderate; depends on JDA terms	Viable alternative