January 7, 2026 : The Mumbai Bench of the Income Tax Appellate Tribunal has held that when a taxpayer receives an ownership flat in exchange for surrendering tenancy rights under a redevelopment agreement, the fair market value (FMV) of the flat on the date of acquisition constitutes the cost of acquisition for computing capital gains on its subsequent sale.
The decision was delivered by a Bench comprising Amit Shukla, Judicial Member, and Arun Khodpia, Accountant Member, in I.T.A. No. 4080/Mum/2025, in the case of Murtuza Kothari v. ITO, relating to Assessment Year 2015–16.
The dispute arose from the sale of a residential flat in Mumbai for ₹86 lakh. The taxpayer had not originally filed a return of income, as the income computed after capital gains was below the taxable limit. On receiving information about the property sale, the Assessing Officer reopened the assessment under Section 147 of the Income-tax Act, 1961.
During reassessment, the taxpayer declared long-term capital gains of about ₹2.37 lakh after claiming an indexed cost of acquisition of ₹83.62 lakh. This cost was computed by adopting the FMV of the ownership flat on the date it was received under a redevelopment agreement, in lieu of surrender of ancestral tenancy rights held under the pagdi system.
The Assessing Officer rejected this computation, holding that the flat had been acquired without monetary consideration. Treating the surrendered tenancy rights as self-generated, the officer invoked Sections 49 and 55 of the Act and adopted the cost of acquisition as nil, thereby taxing the entire sale consideration of ₹86 lakh as long-term capital gains. Exemptions claimed under Sections 54 and 54F were also denied for want of supporting documents. The Commissioner of Income Tax (Appeals) affirmed this view.
On further appeal, the Tribunal examined the true nature of the transaction. It noted that the original property was held as tenancy rights by the taxpayer’s father and later devolved upon the legal heirs. Under the redevelopment agreement, those tenancy rights were surrendered and, in return, an ownership flat was allotted. What was eventually sold was not tenancy rights but a newly acquired ownership flat, which is a distinct capital asset.
Relying on settled judicial precedent, including decisions of the Mumbai Tribunal and the Bombay High Court, the ITAT reiterated that tenancy rights are valuable and transferable rights. Their surrender in exchange for an ownership flat cannot be treated as a cost-free transaction. The Tribunal observed that, absent such surrender, the taxpayer would have been entitled to monetary compensation or its equivalent, clearly establishing the existence of a cost element.
The Bench further held that Section 49, which deems cost of acquisition in cases of inheritance or succession, had no application once the tenancy rights were converted into a different capital asset in the form of an ownership flat. In such circumstances, the FMV of the flat as on the date of acquisition under the redevelopment agreement represents the true cost of acquisition for capital gains purposes.
Accordingly, the Tribunal directed the Assessing Officer to recompute the capital gains by allowing deduction of the FMV-based cost of acquisition with applicable indexation benefits. However, on the issue of exemption under Sections 54 and 54F, the Tribunal upheld the findings of the lower authorities, noting that the taxpayer had failed to substantiate the claim with requisite documentary evidence. The denial of exemption was therefore confirmed.
The appeal was partly allowed, with the issue of cost of acquisition decided in favour of the taxpayer, while the rejection of exemptions under Sections 54 and 54F was sustained
