Home Loan benefits on Income tax

The Income Tax authorities look with favour upon those servicing a housing loan from specified financial institutions. And, it is up to you to be wise enough to take advantage of this.

Let's start with Section 24 of the Income Tax Act

Interest paid on capital borrowed for the acquisition, construction, repair, renewal or reconstruction of property is entitled to a deduction. That means you are allowed to deduct an amount equivalent to the total interest payable on the housing loan from your taxable income within the same financial year.

This is now a substantial amount. It started off with the Income Tax Department offering Rs 15,000 as the maximum amount eligible for deduction in the case of self-occupied property. This later got doubled to Rs 30,000. It did not stop there. After getting enhanced to Rs 75,000, it was then taken to a limit of Rs 1 lakh. Presently, the limit stands elevated to Rs 1.5 lakh. So, should you borrow money to acquire, construct, repair, renew or reconstruct property on or after April 1, 1999, you get a deduction of up to Rs 1.5 lakh. The criteria being: the property has to be acquired or constructed by March 31, 2003.

However, if the property financed is rented out, then there is no ceiling on the deduction from income from house property on interest on borrowed capital. Which means that you can deduct the full interest on borrowed capital. When put in figures, this is quite an amount.

Assume taxable income of Rs 4 lakh, placing the assesse in the highest tax bracket.
Assume interest payment during the first financial year is Rs 1.60 lakh
Taxable income stands reduced to Rs 2.5 lakh (Rs 4 lakh - Rs 1.5 lakh)
Total tax amounts to Rs 49,980 (tax of Rs 49,000 + surcharge of Rs 980)
Tax saved is Rs 45,900 (tax @30% on Rs 1.5 lakh plus 2% surcharge as the investor is in the highest tax bracket).

If you have given the home on rent at, say, Rs 7,000 per month, then you will be able to write-off the Rs 84,000 income against the Rs 1.60 lakh paid as interest. The balance interest outgo of Rs 76,000 [Rs 1.60 lakh (as there is no bar on claiming interest on borrowed capital if property is let out) - Rs 84,000] can written off as a loss against your salary income, reducing your taxable income to Rs 3.24 lakh.

Since the deduction is from the rental income, the latter will also get clubbed with the other income. Tax will be charged on your taxable income after reducing the allowable deduction under Section 80 of the Income-tax Act. Tax incidence can be reduced by investing in certain instruments.

That brings us to Section 88 of the Income Tax Act.

You get a 20% rebate on repayment of principal during a financial year. Once again, over the years, the principal repayment eligible for rebate has been enhanced from Rs 10,000 to the current limit of Rs 20,000. Stamp duty, registration fee or other such expenses paid for the purpose of transfer of such house property to the assesse is also considered under this amount.

Going back to our earlier example:

Taxable income of Rs 4 lakh
Taxable income stands reduced to Rs 2.5 lakh
Tax before rebate and surcharge: Rs 49,000 (no surcharge is computed as surcharge is applicable on tax payable after allowing for rebate under Section 88)
Rebate of Rs 4,000 (20% of Rs 20,000 being principal repayment)
Tax less rebate of Rs 4,000 + surcharge @ 2%= Rs 45,900
Tax saved = Rs 49,900 (Rs 45,900 as shown above plus rebate of Rs 4,000).

So, we can conclude that In the current Housing Finance Scenario borrowing funds for a Home has become a extremely tax saving device.