Unused Capital Gains Funds Trigger Tax Liability

The deposit is a promise, not the exemption

A seller transfers a plot, books a long-term gain, and is not ready to buy the replacement house. The familiar advice is to park the unspent consideration in a capital gains deposit account before the return is filed, claim the exemption, and buy later. That sequence is lawful. Note that the deposit starts a clock that no filing, acknowledgement or certificate can extend.

The provision does not give relief because money was deposited. It gives relief because money was invested in a residential house. The deposit is a procedural bridge that lets a return be filed before the house is bought. If the bridge is never crossed, the relief is taken back — and it is taken back by a computation, not by a notice of reversal.

Which section applies to which year

Two statutes are in play, and the year of transfer decides which one governs. For transfers up to 31 March 2026 the Income-tax Act, 1961 applies, and the provision is section 54F. For transfers on or after 1 April 2026 — tax year 2026-27 onwards — the Income-tax Act, 2025 applies, and the corresponding provision is section 86.

This article speaks in the language of section 86, because that is the provision a seller transferring property today will be examined under. If your transfer fell in an earlier year, the 1961 Act as it stood for that year governs the original claim, and this section should not be read back into it.

What happens when a claim made under the old Act goes wrong after the new one starts is dealt with separately, by section 536(2)(h) of the 2025 Act. Where a deduction was allowed, or an amount was left out of total income, for a tax year beginning before 1 April 2026 subject to conditions, and a condition is violated in a tax year beginning on or after that date, the sum that the repealed Act would have required to be included is deemed to be the income of the tax year in which the violation takes place, and is included under the same head of income as it would have been under the repealed Act. The year of the breach, not the year of the transfer, is the year of charge.

Who can use it, and on what

Section 86(1) is open to an individual and to a Hindu undivided family. It applies to capital gains from the transfer of a long-term capital asset that is not a residential house — listed shares, jewellery, land, unlisted shares, and so on. A gain on a flat you already owned is outside this section; it has its own provision.

The trigger in section 86(1)(b) is one residential house in India: purchased within one year before, or two years after, the date of transfer, or constructed within three years after that date. Both the backward window and the forward window matter, because a house bought in anticipation of the sale counts.

When the money must be parked

Section 86(2) deals with the case where the net consideration is not fully applied in time. Three requirements sit there, and each is a condition:

• the unutilised amount must be deposited in a specified bank or institution and utilised as per the scheme notified by the Central Government — section 86(2)(a);
• the deposit must be made before the return is filed and not later than the due date for filing the return under section 263 — section 86(2)(b);
• the proof of deposit must be submitted along with that return — section 86(2)(c).

Two consequences follow. First, the last date for the deposit is tied to the return due date for the year of transfer, not to the date of the sale, so a seller who files early has less room than a seller who files late. Second, the deposit has to be evidenced in the return itself — a deposit made afterwards, even before assessment, does not satisfy the sub-section as drafted.

Section 86(3) then supplies the fiction that makes the claim work: the amount already utilised, together with the amount deposited, is deemed to be the cost of the new asset, subject to the ₹10 crore ceiling in section 86(8).

What is charged, and in which year

Where a deposited amount is not wholly or partly utilised for purchase or construction within the period in section 86(1), section 86(4)(a) does not reopen the year of transfer, and it does not tax the gain in the year the exemption was claimed. It charges a computed figure as income of the tax year in which three years from the date of transfer of the original asset expires.

The computation is a formula, X minus Y. X is the capital gains that were not charged under section 67 by virtue of section 86(1). Y is the capital gains that would not have been charged if the cost of the new asset had been taken to be the amount actually utilised. In plain terms, the department recomputes the exemption as if only the money actually spent had been spent, and the difference is charged under section 67 as income of the tax year in which three years from the date of transfer expire.

Note what the sub-section does not say. It does not describe the sum it charges as a long-term capital gain; the words are "charged under section 67 as income of the tax year". The long-term label appears in the section's other charging provisions — section 86(6) and section 86(7), which deal with a second house and with a sale of the new asset.

Note also the fixed reference point. Even where the buyer had only two years to purchase, the shortfall is still charged in the year in which the three-year period from transfer expires. A seller who deposits and then does nothing meets the charge in that tax year — not immediately, and not in the year of the original sale.

The proportionate share question

Section 86(1) is not all-or-nothing, and the arithmetic in section 86(4) assumes that. If the net consideration exceeds the cost of the new asset, the exemption is limited to the same proportion of the capital gain as the cost of the new asset bears to the net consideration — section 86(1)(i). If the net consideration is equal to or less than the cost of the new asset, the whole of the gain is not charged — section 86(1)(ii).

So a seller who buys a cheaper house than the one sold has already accepted a partial exemption and a partial charge. The deposit and the formula govern only what happens to the remainder.

A worked illustration

Assume net consideration of ₹200 lakh, a long-term capital gain of ₹80 lakh, and a deposit of the full ₹200 lakh before the return due date. At that point the deemed cost of the new asset is ₹200 lakh under section 86(3), which equals the net consideration, so nothing is charged under section 86(1)(ii). X is ₹80 lakh.

Three years pass and only ₹150 lakh is actually applied to a house. The ₹50 lakh never used is the amount section 86(4)(a) operates on. Y is recomputed with a cost of ₹150 lakh: the gain that would not have been charged is 80 × (150 ÷ 200) = ₹60 lakh. X minus Y is ₹20 lakh, charged under section 67 as income of the tax year in which the three-year period from transfer expires. The cross-check is direct: ₹20 lakh is the same as 80 × (50 ÷ 200), the share of the gain attributable to money that was never invested.

Three events that undo a completed purchase

Buying the house is necessary but not sufficient. Section 86 withdraws or claws back the relief in three situations worth testing before a claim is made:

• Section 86(5): the relief does not apply at all if, on the date of transfer, the assessee owns more than one residential house other than the new asset; or purchases another residential house within one year; or constructs another residential house within three years — where the income from that other house is chargeable under the head "Income from house property".
• Section 86(6): if, within two years of the transfer, the assessee purchases another residential house, or constructs one within three years, whose income is chargeable under "Income from house property", the gains not charged are taxed as long-term capital gains of the year in which that other house is purchased or constructed.
• Section 86(7): if the new asset itself is transferred within three years of its purchase or construction, the gains not charged are taxed as long-term capital gains of the year of that transfer.

The third one catches ordinary life events — a job move, a family change, a better house. The three-year lock runs on the new asset, from its purchase or construction, not from the original sale.

The ₹10 crore ceilings

Two ceilings sit in the section, and both bite at the top end. Under section 86(8), if the cost of the new asset exceeds ₹10 crore, the amount above ₹10 crore is not taken into account for section 86(1). Under section 86(9), if the net consideration on the transfer of the original asset exceeds ₹10 crore, the amount above ₹10 crore is not taken into account for section 86(2).

The second ceiling changes deposit behaviour. A seller whose net consideration is above ₹10 crore cannot shelter the whole of it by depositing the entire sum; the deposit provision stops counting the excess.

Getting the money back out

Section 86(4)(b) answers the question asked at every counter: where the deposited amount is not utilised, the assessee is entitled to withdraw the unutilised amount in accordance with the scheme referred to in section 86(2). The withdrawal is not a second charge. The charge is already fixed by the formula in section 86(4)(a); the withdrawal is the mechanical step that returns money the exemption never covered.

A sequence that holds up

For a seller using the deposit route, the defensible order of events is:

• Fix the sale date and the long-term character of the asset before anything is filed.
• Test the ownership position on the date of transfer against section 86(5) — how many residential houses.
• Compute the net consideration and identify the portion that will not be applied within the section 86(1) windows.
• Deposit that portion before the return is filed and not later than the return due date under section 263, and keep the deposit proof ready to attach — sections 86(2)(b) and 86(2)(c).
• Diarise the three-year anniversary from the date of transfer as a charging date under section 86(4)(a), not as a reminder.
• Re-test sections 86(6) and 86(7) at every purchase, construction and sale of a house for the next three years.

Where the deposit route can go wrong

Three mistakes are worth avoiding. The first is treating the deposit as the end of the matter and never reopening the file in the tax year in which three years from the transfer expire, when the formula actually operates. The second is buying the replacement house and selling it inside three years, which brings section 86(7) into a transaction the seller thought was finished. The third is filing the return before the deposit and assuming the deposit can be shown later; section 86(2) is written as a sequence, and the sequence is part of the condition.

None of this makes the deposit route unattractive. It makes it a dated commitment. The section gives a seller time to buy. It does not give a seller time to decide.

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See Also

• Undisclosed Assets: The 78% Tax Trap for Cash, Gold & Investments (AY 2026-27)

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