Bombay High Court: Second Flat’s Cost Is Not Your Income — the Section 54F Ruling Explained

A Mumbai taxpayer sold tenancy rights and shares, made a large long-term capital gain, and put the money into two adjoining flats he intended to live in as one home. He claimed the section 54F exemption on both. The Assessing Officer said no to the second flat — and then did something much worse than saying no. He added the entire ₹4.78 crore cost of that flat to the taxpayer’s income.

The tax demand jumped from roughly ₹38 lakh of pre-deposit to a computed tax of ₹1.53 crore. On 2 November 2026, the Bombay High Court pulled it apart.

What actually happened

The facts, as recorded in the judgment in Nilesh Ramesh Modi v. The Income Tax Officer, Ward 16(3)(1), Mumbai & Ors., Writ Petition No. 4898 of 2026, decided by a Division Bench of Justices B.P. Colabawalla and Farhan P. Dubash:

Note the case was decided under the Income-tax Act, 1961 — it concerns AY 2024-25, so the old Act’s sections apply. Section 54F in the new Income-tax Act, 2025 sits in the same place conceptually, but this ruling is about the 1961 Act’s text.

The department’s mistake, in plain English

Section 54F gives you an exemption from long-term capital gains when you invest the net sale consideration of a long-term asset (other than a residential house) in buying or constructing a residential house. If the investment is smaller than the full sale consideration, the exemption is proportionate — section 54F(1)(b) gives you exemption only in the ratio of the amount invested to the net consideration.

Here’s the catch the Assessing Officer missed: denying the exemption for the second flat doesn’t mean the flat’s cost becomes your income. It means the exemption shrinks proportionately. The taxpayer’s own revised computation — which the department’s counsel did not dispute — showed the correct capital gains at ₹2,93,47,526. The officer’s version, ₹13.24 crore, was more than four times that.

The court’s point was narrow but important: rejection of an exemption claim does not authorise the officer to adopt an incorrect method of computing capital gains. The computation must follow the statute. You can disagree about whether the exemption applies; you cannot invent a new way of adding things up.

One thing the court deliberately did not decide: whether two adjoining flats intended to be used as a single residential house actually qualify as “one residential house” under section 54F. That question stays open — and it matters, because a Mumbai ITAT bench in September 2026 (in the S Shah case) held that two flats on different floors of the same building could qualify as one house, looking at the substance and functional character of the accommodation rather than the number of registered instruments.

What this means if you claimed 54F on two flats

If you bought two adjoining flats and claimed the exemption on both, three things follow from this ruling:

1. Check your assessment order’s arithmetic, not just its conclusion. The officer in this case reached ₹5.95 crore in the order’s text but ₹14.03 crore in the computation sheet — the two didn’t even agree with each other. If your demand looks wildly out of proportion to your gain, the computation itself may be wrong. Our scrutiny notice guide explains how to read an assessment order line by line.
2. The proportionate formula is your friend. Even if the department disallows the second flat, the correct outcome under section 54F(1)(b) is a proportionate exemption — not a full addition of the flat’s cost. Work out your own number with the formula before accepting a demand. If the numbers don’t add up, our income tax demand notice guide — agree, pay or dispute sets out the rectification and appeal routes.
3. The “one house” question is still live. The High Court left it undecided, and the ITAT’s September 2026 view (substance over form) helps taxpayers — but it is a tribunal view, not a High Court ruling. If you are planning a two-flat purchase, document the single-house intention from day one: one agreement referencing both units as a single residence, a single architect’s plan, common utilities. Modi’s 13 July 2023 letter stating the intention helped him; the department still fought it.

The stay-relief part matters too

The practical half of the ruling matters too. The taxpayer had been asked to pre-deposit ₹38.75 lakh to stay recovery of the demand while his appeal was pending. The court cut that to ₹6,50,108 and stayed recovery of the remaining ~₹32.24 lakh until the appeal is decided.

That is a useful precedent in itself: when the demand rests on an obviously wrong computation, courts will reduce the stay condition drastically. If you are facing a demand you believe is wrongly computed, the stay application is where you fight the cash-flow battle — not just the appeal. And if you sold a house and are working out the tax, our capital gains guide for selling a house — the indexation choice, old vs new computation walks through the same section 54F mechanics with worked examples.

FAQs

Can the department add the full cost of a second flat to my income if 54F is denied?
No. The Bombay High Court held in November 2026 that denying the exemption does not authorise adding the flat’s entire purchase cost to income. The exemption is computed proportionately under section 54F(1)(b).

Do two adjoining flats count as “one residential house” under section 54F?
Undecided by the High Court in this case. A Mumbai ITAT bench in September 2026 said yes, looking at substance and function — but that is a tribunal view, and the question remains open for higher courts.

What was the correct capital gain in the Modi case?
₹2,93,47,526, as per the taxpayer’s revised computation under section 54F(1)(b) — a figure the department’s counsel did not dispute. The department had computed it at ₹13.24 crore.

What is section 54F?
It exempts long-term capital gains when you invest the net sale consideration of a long-term asset (other than a residential house) in buying or constructing a residential house in India, subject to conditions — including not owning more than one residential house (other than the new one) on the transfer date.

Does this ruling apply to the new Income-tax Act, 2025?
The case was decided under the 1961 Act for AY 2024-25. The 54F exemption concept continues under the new Act, but the ruling’s authority is tied to the 1961 Act’s text — cite it for the computation principle, not as a new-Act ruling.

Sources

Nilesh Ramesh Modi v. The Income Tax Officer, Ward 16(3)(1), Mumbai & Ors., Writ Petition No. 4898 of 2026, Bombay High Court (Division Bench: Justices B.P. Colabawalla and Farhan P. Dubash), decided 2 November 2026 — judgment text via LiveLaw (CNR No. HCBM020330182026). Case summary and figures as reported by TaxGuru and ANP TaxCorp, November 2026. Section 54F of the Income-tax Act, 1961. Related reading: our income tax hub for every capital-gains and exemption guide.