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Watch Out! No Home Loan Tax Benefit On House Under Construction

You are, of course, well aware that your home loan enjoys tax benefits. For a self-occupied property, you can claim tax deduction on
a) interest payment (up to Rs.2 lakhs), 
b) principal repayment (up to Rs.1.5 lakhs).

This benefit is available every financial year, till the loan is fully repaid.

However, not many people know, that this rule applies ONLY on the properties ready for occupation.

Therefore, as per the present tax laws
(a) no tax deduction can be claimed while the house is under construction, and
(b) only a part portion of the pre-completion EMIs paid, can be claimed later.

In other words, the tax deductions 
- under section 24 of the Income Tax Act (pertaining to the interest payment on home loans) and 
- under section 80C (pertaining to the principal repayment on home loans)
are applicable ONLY AFTER the property is complete and ready for possession.

India is a growing economy. Consequently, real estate construction is booming across the country. As such, it is quite common for people to buy properties that are still in the construction phase. In fact, in many instances maybe only the land has been acquired, and the construction activity is yet to begin.

Secondly, it is also quite common for such under-construction properties to be financed through a home loan.

Hence, many EMIs in the initial few years, are paid while the property is still incomplete.

Therefore, it is of paramount importance to understand the income tax rules that apply to these "pre-completion" EMIs.

Else, you may end-up claiming wrong tax deductions, and thus become liable to pay penalty when the mistake is detected by the income tax officer.

Principal part of the Pre-completion EMIs

NO DEDUCTION is available for the principal portion u/s 80C:

In other words, principal amount repaid during the construction period, is a total waste from the taxation angle. It enjoys absolutely NO tax benefits.

In fact, even the stamp duty and registration charges can be claimed for tax deduction u/s 80C, ONLY IF the property is completed during the financial year in which you incur these expenses.

If not, even these charges enjoy NO tax benefit, ever again.

Mamaaaa... I am not getting any tax breaks on my under-construction property.

Interest part of the Pre-completion EMIs

You CANNOT claim any deduction on the interest paid, while the construction is in progress.

However, the good news is that unlike principal this benefit is not totally lost. It can be claimed later, after the property is complete and ready for occupation.

In this regards,
1. You have to add-up the total interest paid, till the year prior to the year of completion.
2. This total pre-completion interest can be claimed for tax deduction over a period of 5 years.
3. The 1/5th deduction starts from the year of completion and continues for 4 years thereafter.

For example:

Suppose you took a loan in 2011-12 and the property was ready for possession in 2013-14. Meanwhile, you paid a total interest of Rs.4 lakhs during 2011-12 and 2012-13. Hence, you can claim Rs.80,000 (= Rs.4,00,000 / 5) for tax deduction beginning from 2013-14 and till 2017-18.

What if the construction gets over during mid-year:

Interest during the initial months of the year, when the construction was in the final stages, is simply added to the interest during the later part of the year after the property is complete. In other words, you don't have to bifurcate the interest between pre and post-completion, during the year of completion. Every rupee is considered as post-completion interest.

Loss of Tax Benefit on the Interest Portion

Home loan amounts are generally quite high. As such, the normal annual interest (after the property is complete and the full loan is disbursed) is usually already much more than the specified limit of Rs.2 lakhs. Therefore, even if 1/5th of the under-construction interest can be deducted, there isn't sufficient limit available to do so.

Hence, many people often lose the benefit of even the interest paid during the construction phase.

Of course, this problem may not arise in the smaller cities and towns (or the affordable housing projects announced by the Govt. in bigger cities) where the property prices and consequently the loan amounts will not be high.

Construction period cannot be unlimited

In order to be eligible to claim the tax deductions on home loan interest and principal, AFTER possession, it is important that the construction is completed within a specified period.

Earlier, this period was 3 years.

However, project delays by the developers are quite common. As such, numerous people lose their eligibility to claim tax deductions on account of no fault of theirs.

Hence, to mitigate the hardship of helpless property buyers, the Govt. has relaxed this period to 5 years w.e.f. the Financial Year 2016-17.

Before we end, a couple of important points:
1. In certain cases, an additional deduction of Rs.50,000 on interest payment can be claimed, over and above the limit of Rs.2 lakhs (Sec 80EE).

2. If the property is sold within 5 years, the tax deduction claimed on the "principal repaid" in the past, would be reversed and you would be liable to pay extra tax in the year of sale. However, there is no impact on the tax benefit claimed on the "interest portion". It remains as it is.

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