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Your Tax Benefits Are Hereby Cancelled And Revoked

Income Tax Act offers you many deductions and exemptions, which help you to reduce your total tax payable for the year.

Beware! The deductions and exemptions that you claim, are not permanent in nature.

Failure to comply with the prescribed conditions, would result in the reversal of such benefits claimed by you in the earlier years. And, you would become liable to pay the additional tax liability thereof.

Quite often people have — unknowing and inadvertently — violated these conditions. End result - Unnecessary and Avoidable Tax Burden!

A few of the common instances in this regards are discussed below.

Tax benefit on home loan principal repayment

It is common knowledge that, your home loan monthly EMI payments, are eligible for tax deduction.

The "interest portion" of the total EMIs payable by you during the financial year, is allowed as deduction (subject to a maximum of Rs.2 lakhs) from your total taxable income. This tax benefit on home loan interest is covered under Sec 24 of the Income Tax Act. It can substantially bring down your income tax liability.

In addition, you can claim deduction on the "principal portion" of the total EMIs paid during the year. This falls under Sec 80C and the total limit for all specified investments / expenses put together is Rs.1.50 lakhs. (By the way, do you know the best deductions u/s 80C to slash your income tax?)

It is the tax benefit claimed on the "principal portion" which would be reversed, if...
... you transfer or sell you sell your house 'before the expiry of FIVE years from the end of the financial year in which possession of such property is obtained'.

In other words, total deduction claimed on the principal amount repaid in the past, will be deemed as your income for the year in which you sell the property; and taxed accordingly.

(Note: If you receive back, as a refund or otherwise, any principal amount repaid earlier, the same too shall be treated as your income for that year.)

Therefore, be very careful of when you sell your property, on which you have enjoyed home loan tax breaks. Or else, be prepared to forgo these benefits.

Interestingly, no such rollback is mandated for the tax benefit claimed on the interest part.

Tax deductions / exemptions claimed in the earlier years may be upturned, if you...

Tax benefit on capital gains from sale of property

Income Tax Act is (sometimes) very generous.

You need not pay ANY tax, on the lakhs of rupees of gains, made on the sale of property.

As per Sec 54 of the Income Tax Act, if you sell any property, the tax payable on the capital gains is NIL, Provided
a) you have owned and held the property for more than three years,
b) the capital gains have been invested in a new property (within a specified period)
b) the capital gains have been invested in specified NHAI / REC bonds (within a specified period)

(Note: Since investment in bonds is restricted to Rs.50 lakhs only, this option may not always be sufficient enough to save tax on the entire capital gains.)

You can continue to enjoy this (big) tax benefit, as long as you do not RESELL this newly acquired property "within three years" from the date of purchase / construction.

If you do so, this tax exemption stands null and void.

Since the new property has been sold within three years, it is short term capital gains. Such gains are fully taxable. Unlike long term capital gains, they enjoy no benefit at all.

Further, to reverse the tax benefit claimed on the earlier property, tax on this short term capital gains 
will apply not on... 
... the simple gains (= Sale Price of new property - Cost Price of new property) 
but on...
... the revised gains (= Sale Price of new property - Cost Price of new property + Amount claimed as tax deduction on the old property).

So, again you need to be extremely careful of timing your property sale and purchase. Otherwise, the consequences could be seriously damaging.

Meanwhile, here's tax on sale of property made really simple for you.

Tax benefit on purchase of life insurance policy

Insurance policies are one of the most preferred routes in India to save tax (of course, with disastrous results as explained in my blog post My name is insurance and I am not an investment).

And, as is often the case, this happens generally during Jan to Mar period, when there is rush to meet the deadline of Mar 31st.

Later, however, many policyholders do not stay committed to these policies. 

This could be either due to financial constraints, which they hadn't anticipated earlier. Or, they realize that the policy is atrocious and hence not worth continuing. Or, the policy does not offer what they had expected.

As a result, they stop paying their premiums.

And, this is where the tax benefits claimed in the past, get revoked.

Income tax rules stipulate that, such tax benefits claimed in the earlier years would become your income (and hence taxable), if you haven't paid at least
a) "two years" premium in case of a traditional policy like moneyback or endowment; and 
b) "five years" contribution in case it is a ULIP (unit linked insurance plan).

As is evident from the above discussion, the tax benefits granted under the Income Tax Act, are generally available only if there is a long term commitment.

You would, therefore, do well to think through your tax-saving options thoroughly... and beforehand. Last-minute impulsive decisions will only make you regret later.

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