Avail Home loan, create asset and save tax!

In an era of declining interest rates on bonds and fixed deposits, fluctuating gold price & uncertain stock market, the subdued real estate climate in the urban cities provides the average investor to bargain a good deal and in turn use home loan as an instrument for better tax exemptions.

A home loan can help you accomplish the daunting task of buying a good residential property. You enjoy tax exemptions on the loan taken when you repay it and get a large asset in place in your working life. Thus you can create a large asset which pays you in your retired life. Let us now get an insight into the tax exemptions for home loans.

All put together, an individual can enjoy an exemption on the interest paid up to Rs 2,00,000 per annum and Rs 150,000 on the principal amount on a self-occupied property. For instance a home loan of Rs 40,00,000 with an interest rate of 9.5% for a 15 year tenure would result in an equitable monthly installment (EMI) of Rs 41,769.

This would mean annual principal outgo starting from Rs 1,25,000 of principal amount and interest outgo of Rs 3,55,000 per annum. The annual amount will vary as the tenure progresses with principal amount rising and interest quantum reducing. An individual in the 30% tax bracket will be able to reduce his liability by Rs 60,000 annually based on his interest outgo of Rs 2,00,000.

The amount of Rs 150,000 which would have otherwise been invested in PPF can be now set-off against the principal repayment made on the home loan. Hence for a salaried employee with an earning of Rs 15,00,000 per annum with and without a home loan will have the following tax outgo:

Particulars    Without home loan    With home loan Gross Income 
Gross Income                 1,500,000       1,500,000
Less Medical Insurance                      25,000            25,000
Less PPF                    150,000            25,000
Income before benefits Of Home Loan                 1,325,000       1,450,000
Less: Repayment of Home Loan                            –          125,000
Less: Home Loan Interest                            –          200,000
Total Taxable Income                 1,325,000       1,125,000
Less: Standard deduction                    250,000          250,000
Taxable Income                 1,075,000          875,000
10% on first 2,50,000                      25,000            25,000
20% on next 500,000                    100,000          100,000
30% on the balance thereafter                      97,500            37,500
Total tax outgo (Excl. Cess)                    222,500          162,500

 

The above table indicates that with home loan an individual is able to save Rs 60,000 more due to a reduced tax outgo and also an asset is generated in the process.

Assuming an individual and his wife are in the income bracket of Rs 10 lakh per annum, they can jointly opt for a home loan and the tax exemptions benefit can be doubled or in other words each individual can enjoy the entire Rs 350,000 exemption separately. An individual can also avail the deduction on the interest payable for the pre- construction period.

Such interest is deductible in five equal annual installments commencing from the year in which the construction of the property has been completed. The same is included within the overall limit of deduction of Rs. 2,00,000. There are some caveats to the exemption. Deduction of Interest up to Rs.2, 00,000 per annum, is allowed on the capital borrowed for the purpose of purchase, construction of a self-occupied property provided the acquisition or construction of property is completed within three years from the end of the financial year in which the loan is taken.

More often, there is delay in the construction and the borrower loses on the tax incentive without any of his fault, hence it is advisable to make a thorough study of the period of completion, clearance of land from local government, credibility of builder etc. Also to address this issue the Budget 2016 has increased this time limit from 3 to 5 years from financial year 2016-2017.

Unlike pre-construction interest, the deduction on principal payments is allowed only on completion of construction of the house. Hence it is prudent to obtain the completion certificate of construction to claim such tax benefits. It is pertinent to note that if you sell the house within 5 years of taking possession, the deductions claimed on principal payments are reversed. The amount deducted in previous years is considered as income in the year of sale and taxed accordingly.

The afore-said deductions can also be claimed even in case of a let-out property provided you declare rent income. Also there is no limit on the quantum of deduction of interest in case of let out property, the principal repayment will be the same as in case of self-occupied property.

Additional Deduction of Interest up to Rs. 50,000 can be claimed u/s 80EE of the Act towards loan taken for residential house property, to incentivize first time individual home buyers, if asset value & loan amount does not exceed Rs 50 lakh and Rs 35 lakh respectively. The deduction under the proposed section is over and above the limit of Rs 2,00,000 for interest outgo provided under section 24 of the Act.

The individual must also preserve the statement provided by the financer clearly specifying the amount payable and paid towards Interest and Principal.

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