My client, Gopal had just bought his dream home in Mumbai worth Rs 4.50 crores and had taken a home loan of Rs 3.50 crore to acquire the house. We got talking at his house-warming party and he told me that he loved his new home. The only issue was that he would be paying home-loan interest of approximately Rs 30 lakh in the first year, but, would be able to get deduction of only a maximum of Rs 2 lakh. He wanted to know if there was anyway he could get the deduction for the entire interest payable. If he managed to get deduction for the entire interest of Rs 30 lakh, it would lead to an additional tax saving of Rs 9 lakh approximately, in the first year itself.
This was a substantial sum of money even for somebody as well off as Gopal and I was amazed that he had not already consulted experts for this. There is a very easy and perfectly legitimate way in which almost the entire home-loan interest could still be claimed as deductible by him. Here is what I told him.
Me: You have always wanted to buy a small second home. Go ahead and buy that now.
Gopal : How will that help me to claim full deduction on the first home loan?
Me : It’s really quite simple. Most people don’t know that they have to do a calculation of taxable rental from every property owned by them. For every property owned by them, the rental income actually earned would be taxable. In case any of the property(ies) was not rented out, the notional rent on that property is taxable. In short, on every property owned by an individual, he has to offer for taxation the amount of rental earned or the notional rent it could have earned.
Gopal was incredulous : My house can be rented out for Rs 62,500 per month. You mean I have to actually pay tax on the notional rent of Rs 7.50 lakh per year that my home would have got had I rented it out ?
Me : Not so fast – Gopal. First, only 70% of the rent or notional rent is taxable. Second, even from this reduced taxable figure, the home-loan interest is also deductible and only the net income is taxable.
Gopal : The taxable notional rental in my case is Rs 5.25 lakh (70% of Rs 7.50 lakh). From this figure of Rs 5.25 lakh, how much do I have to deduct for home-loan interest ? Is it Rs 2 lakh or the entire Rs 30 lakh? If I take Rs 2 lakh only, the net taxable income from the property is Rs 3.25 lakh. It is incredible if I have to pay tax on this notional taxable income of Rs 3.25 lakh despite not having given the property on rent and incurring such heavy interest cost.
Me : Exactly the reason why the government says that for a property which is self occupied by the tax payer, the notional rent is taken as nil. Hence in your calculation, the loss from the property will be Rs 2 lakh which you can set off against your salary income and your tax payment will be lower to that extent. But, accepting this working would mean that you will not be able to get any tax benefit for the other Rs 28 lakh of interest paid by you. Whereas, if you agree to pay tax on 70% of the notional rent then you will be allowed to claim the full interest as deductible.
Gopal was incredulous : You mean if I agree to pay tax on 70% of the notional rent (Rs 5.25 lakh), I can deduct the entire Rs 30 lakh as interest leaving me with a net loss of Rs 24.75 lakh. Can I set off this loss against my salary Income? That is a straight additional tax benefit of Rs 7 lakh in the first year.
Me : You can do that provided you have another self occupied property and you treat the notional rental value of that property as nil. So, buy that small Rs 10 lakh-house property that you have always wanted to buy in your native village. You will not only have the long-desired second home but will also recover its cost from the additional tax benefit on your existing home. What’s more? If you take a loan to fund this house, the interest payable on that home loan is also deductible upto Rs 2,00,000.
Gopal : Anything else I should take care of?
Me : Just make sure that the second home is occupied by you prior to the end of the financial year. So, buy a ready property and don’t forget to invite me to the house warming party of the second home as well.
If readers of this column find this perfectly legitimate advise incredible, they can get it checked with their tax consultant. I am sure they will back me up.
Harsh Roongta is a CA and Sebi-registered investment advisor. Send your queries to firstname.lastname@example.org or tweet them to @AskHarshdna