Tax benefits you should know before taking a home loan

Know the rules governing tax benefits of a home loan to make the most of this sop.

Thursday, December 17, 2015

Understanding taxes is not easy. At the time of buying a house, the broker may talk about the huge tax benefits of taking a home loan, even suggest that bigger is better. However, if you do not look at the terms and conditions, what he says could be misleading.

So, before signing on the dotted lines, understand the tax rules that govern home loans, as a decision made in hurry can impact your future cash fl ow adversely. For instance, tax benefits for under-construction and ready-to-move properties are not the same. In case of under construction homes, tax benefits do not start immediately, while buying a ready-to-move house makes you eligible for tax benefits from day one. Read on to find out the other points you must keep in mind while taking a home loan.

UNDER-CONSTRUCTION PROPERTY

Many people opt for under-construction properties as they are less expensive compared to the ready-to-move ones. But it is important to understand the deal from tax angle as well. 

- First things first. Tax benefits for under-construction properties start only after they are completed. 

- According to the income tax laws, you do not get tax benefit under Section 80C for principal payments made during the construction period. You are eligible for this only after the project is complete. 

- Similarly, one can avail of tax benefits on interest only after the project is complete. 

- The interest paid during the pre-construction period can be claimed as deduction in five equal installments after construction. 

- The interest paid from the date of borrowing to 31st March before the year of construction is allowed as deduction from the year the construction is complete. 

- If you fail to claim the pre-construction interest installment in any of the five years from the year the construction was complete, the amount shall not be carried forward to the next year. 

- The construction should be complete within three years from the end of the financial year in which the loan is taken in order to get a deduction of Rs 2,00,000. Otherwise, you will be eligible for a deduction of only Rs 30,000. 

- If the construction is completed after three years, the income tax department may accept your request if you substantiate your case through legal means.

READY-TO-MOVE PROPERTY

- A ready-to-move property is expensive. But the positive side is that you can avail of tax benefits immediately. 

- If the property is self-occupied, interest deduction up to Rs 2,00,000 is allowed under Section 24, including 1/5th of interest accrued during the construction period. 

- In case the property is let out, the deduction of interest shall be allowed up to the interest payment, without any upper limit . 

- The principal is allowed to be deducted up to Rs 1.5 lakh under Section 80C.

 - If the property is sold within fi ve years, the deduction on the principal is added to income.

 BUYING A PLOT

Vineet Agarwal, Partner, KPMG India, says, "The tax benefits are available for a 'house property', which refers to 'building and land appurtenant thereto'. A plot of land may not be considered as house property and therefore not eligible for tax benefits."

However if you buy a plot and build a house on it, the deduction on interest and principal payments will be similar to that for under-construction property.

Divakar Vijayasarathy, Co-Founder and CEO, MeetUrPro.com, says, "In case a plot is purchased but there is no house-building and the plot is let out, the deduction for principal is not allowed, but the interest paid is allowed against rental income offered under the head Income from Other Sources."

Sudhir Kaushik, Co-founder, TaxSpanner.com, on points to avoid while taking a loan

A) Avoid under-construction properties assuming they appreciate more. This is because the tax benefit gets delayed and is, sometimes, denied too. If the property is bought for self-occupation and possession is not taken within three years of the date of purchase, the interest deduction is not allowed. Tax benefits on ready properties start immediately. Hence, cash fl ow gets eased with deduction for interest and principal up to 30 per cent coming from tax savings. Moreover, you save on rent for the construction period. There are some non-monetary benefits too - you know your neighbors as well as the status of overall development in the area. In under-construction properties, these facilities come in after a very long period.

B) Avoid assumed (interest) savings through prepayment or shorter tenure: Optimise tax savings by balancing house value, loan amount, tenure, earning years left and cash fl ow to get the maximum deduction. For example, one should buy property with spouse or parents and take joint loan if both are earning and are buying for self occupation. There are cases where taxpayers prefer pre-payment or opt for a short tenure ignoring the cash crunch and loss of tax benefits. If your age is 35 and years left to retire are 25, a home loan for 25 years is better than for 10 years from the tax angle.

C) Avoid concentration of assets in real estate by making higher down payment. It has been noticed that people in India keep higher than the recommended share of wealth in real estate and do not go for diversification. Ideally, one should take loan for 75-80 per cent house value, but those have some surplus prefer to take a lower loan in spite of eligibility. This is because they do not think of investing in equities/mutual funds for diversification and liquidity. Needless to say, mutual funds provide tax efficiency over and above diversification and liquidity.

D) Avoid delay in buying house: Many people defer buying a house due to non-availability of required funds. This leads to widening the fund deficit as property prices keep increasing. The better and more tax efficient option is to buy a ready house within your budget on maximum loan to start saving tax as well as money for down payment of the dream house. 

E) Avoid fake/short-term benefits. For example, deals for under construction property are sweetened by free car/gold coin/parking/furniture/electronics which are not more than 5 per cent of the property value in general. However, the loss of tax benefits would be up to 30 per cent EMI (on interest and principal) as both are eligible for deduction if the house is ready for possession.

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