Home loans are the most sought after loans currently, with all banks and housing finance companies competing to garner a major chunk of the consuming public. Government of India has given impetus to the housing boom by extending various benefits. We shall discuss the concessions available under Income Tax Act 1961 to the Home Loans.
Income from house property is one of the recognised heads of income under the Income tax act. The sections 24 and 88 of the act governs various concessions available to the borrowers of home loans. The concessions are of two types, deductions and rebate. Certain expenditures are allowed as deductions out of the income from house property, thus reducing the taxable income. Rebate is the deduction on the tax payable.
We shall first understand deductions that are allowed out of income from house property. Clause VI of section 24(1) of income tax act refers to the deductions. It provides for deduction of interest on capital borrowed for certain specified purposes. They are capital borrowed for acquiring, constructing, repairing, renewal and reconstruction. Please note that loan borrowed on the security of existing building for any other purpose does not fall within any of the above-referred categories.
Acquiring means purchase of a constructed house. It includes the purchase of a site, but the construction should start in the same financial year to avoid any doubts. Repair and renewal are two different things. Repair always ends with renewal. Renewal is different from repair, means reconstruction of something in full, need not be whole, but of a considerable part. Reconstruction is demolition of present structure and building a new structure in its place.
What is allowed as deduction?
1. As already referred earlier, the interest on capital borrowed for some specified purposes are allowed as deduction. The interest is accrued interest i.e., what changed to the loan account in a financial year. There is no need that the assesse/borrower should have paid the interest.
In case of Central Government Employees, and other Public Sector Companies, Banks, generally employer recovers principal first and later on the interest. In such cases also the interest charged to the loan in a financial year is eligible for deduction.
2. Income from any house property is derived only on completion of construction. The completion of construction may take a couple of years. But capital borrowed attracts interest from the day of borrowal. But as there is no income, the interest cannot be deduced out of Income from house property. It cannot be appropriated towards any other type of expenditure. The income accrued on borrowed capital during the period of construction is allowed to be deduced in five annual investments after the completion of construction of the house. This is in addition of the interest of that financial year. To be more clear, we shall study an illustration.
Mr. A has borrowed ‘Rs.10 Lakhs’ on 01/06/2000 to construct a house. The construction was completed on 01/04/2002, from which date the house started generating income. The accrued interest for construction period from 01/06/2000 to 31/03/2002 was Rs.1,30,000. The interest after completion from 01/04/2002 to 31/03/2003 was Rs.60,000. The deduction allowed is as follows for the year 01/04/2002 to 31/03/2003 (Assessment year 2003-04).
a) Pre-construction period:
1,30,000 / 5 Rs. 26,000
b) Interest for year
2002-03 Rs. 60,000
c) Deduction allowed Rs. 66,000
3. Only simple interest that is the interests on capital borrowed is allowed as deduction. Compound interest, which is interest on or unpaid interest is not allowed as deduction. The home loans are repaid by way of Equated Monthly Instalments,(EMI) which are based on simple interest.
4. Only interest accrued during immediate previous year is eligible for deduction in addition to the 1/5 of the interest of pre-construction period.
5. Nature of the loan is most relevant unless the amount is used for specified purpose. It may be even bank overdraft.
6. Even interest on second loan is also allowed as deduction, provided then the second loan is used to repay the first loan availed of for specified purpose. However, the facility is not available for third loan.
Generally, the provision is applicable if the loan is in the name of assessee and occupied/ constructed property also stands in the name of the assessee. There is an exemption. The assessee may borrow and acquire the property in the name of the spouse or minor children. In such cases, the income from the house property in the name of the spouse, minor children will be clubbed with that of borrower as per section 64(1).
7. The determining factor is borrower and lender relationship. The amount borrowed should not be free of interest. There is no need that the lender should be a recognized / approved financial institution. One may borrow from spouse, children, and relatives, creating proper records or documents.
Limit of Deductions
There is a misconception that interest allowed as deductions is limited. Please note that there is no limit in case of capital borrowed to construct the proportions, which are let out. Entire interests is allowed as deduction.
Limitation is only in case of properties which are self occupied. An assessee can have only one self occupied property. Even if he owns more than one self occupied property, he has to choose only one property as self occupied and other properties will be treated as let out, income, from which is taxable based on annual value.
The self-occupied property is on a different footing. The annual value of the self-occupied property is treated as nil, hence, no tax need be paid. The restriction of deduction of interest on self-occupied property was Rs.30,000, it has been increased. This limit may be categorised as follows.
Loans taken for any specified purpose prior to 01/04/1999:- Rs.30,000.00
Loans taken after 01/04/1999 for repay, renewal, reconstruction:- Rs.30,000.00
Loans taken after 01/04/1999 for acquiring/construction:- Rs.1,50,000.00
The limits are per assesse. In case of join ownership each owner may avail of the benefit to the maximum, subject to his share in the property. The act prescribes dates for availing the loans, but not for commencing the constructions. The construction might have commenced prior to 01/04/1999, but if the loan is availed on or after 01/04/1999, deduction is available up to 1,50,000.
This is a concession available on tax payable. Section 88 of the income tax act deals with the rebate. Amounts paid towards principal of capital borrowed is allowed as rebate, which is 20% of the amount repaid with a ceiling of Rs.20,000. The Rebate at 20% is also allowed on stamp duty and registration charges within a ceiling limit of 20,000. If properly planned, Home Loans work as best tax-saving-schemes.
The author is a retired bank manager and an expert in personal finance
Issue BG36 March04