Home loan interest may pose a financial challenge. Nevertheless, through careful planning, it is possible to transform this challenge into a tax-saving opportunity. Here is how you can optimise tax benefits on home loan interest for both self-occupied and rented out properties.
Many people cannot afford to buy a home outright as meeting the one-time cost of buying a house can be difficult, especially with sky-high prices. A home loan thus becomes the preferred choice. Besides making house ownership dreams a reality, home loans come with tax benefits like Section 24 (b) of the Income Tax Act 1961, which provides exemption on interest repayments.
For let-out property there is no restriction on interest deduction u/s 24 i.e. you can opt for a deduction on the entire interest you are paying on the home loan.
For self-occupied property, you can claim a deduction of home loan interest up to ₹2 lakh. But the interest paid on the loan may be higher. In such a scenario, you can add the remaining housing loan interest to the cost of acquisition during the sale of the property. In case of let-out property, you can carry forward losses to later years.
Also Read: What are Home Loan Tax Benefits?
For example, you purchase a house for Rs 2 crore and take a home loan of Rs 1.2 crore. You pay an annual interest of Rs 10 lakh (assuming flat interest payment each year, rather than reducing balance)
Example Calculation for Let Out Property earning Rs 5 lakh annually
A flat deduction of 30% is allowed on the net annual rental value of the property. So you are left with a balance of Rs 3.5 lakh. Now when you factor in the annual interest of Rs 10 lakh that you are paying, you are making a loss of Rs 6.5 lakh. Now the loss under house property income is allowed to be set against rental income up to Rs 2 lakh every year and the excess, if any, will be carried forward and set off over the next eight years against income from house property. So you carry forward Rs 4.5 lakh for 8 years.
Example Calculation for Self-Occupied Property
For self-occupied property, you can claim a deduction of home loan interest up to ₹2 lakh each fiscal year. In this case, you carry forward Rs 8 lakh till you sell the property. When the loan is paid off after 10 years, you sell the house for Rs 3.5 crore.
Section 48 allows the addition of interest paid on a home loan to the purchase price of the house. The addition of housing loan interest to the purchase price is done to calculate acquisition cost of the house when it is sold. This acquisition cost is used to calculate the capital gains/loss incurred on the sale.
So, the cost of acquisition stands at Rs 2.8 crore, after you have added the home loan interest part. So your capital gain stands at Rs 70 lakh.
Also Read: Best Bank For Home Loan in India
Key takeaway
The key takeaway in the self-occupied situation is that you are able to add unclaimed interest to the cost of acquisition to reduce capital gains tax. In case of the let-out property, you set off Rs 4.5 lakh loss against future rental income.
By turning unclaimed interest into a tax advantage for the self-occupied property, you are able to reduce capital gains tax by increasing the cost of acquisition, in addition to creating long-term wealth.
For let-out property, you are able to reduce taxable rental income and the unclaimed interest provides a cushion against future tax liabilities. Also, for the Rs 4.5 lakh loss carried forward for 8 years, future rental income is tax-free up to this amount.
