“He is poor, his neighbour is poor. How do they manage? They borrow from each other.”
This is one of my favourite quotes and explains the importance of borrowing for each of us. This article discusses various tax benefits associated with different loans.
Tax benefits for home loans
Section 24(b) of the Income Tax Act allows you a deduction for interest paid on money borrowed for the purchase, construction or even for the repair or reconstruction of a house property. This benefit is available for both commercial and residential properties. Even the processing fee and prepayment charges paid for a home loan are treated as interest for income tax purposes and are eligible for deduction.
This deduction is available for any money borrowed, whether from banks or friends and relatives, so long as you can prove that the money borrowed was used for the specified purposes. The nomenclature of the loan need not be a home loan.
The amount of deduction which you can claim will depend on whether the property is used for your own residence or is let out, and whether you have opted for the old tax regime or the new tax regime.
If you opt for the old tax regime, you can claim full interest paid for a let-out property, but for a self-occupied property, the deduction is restricted to Rs. 2 lakhs only. If you have more than two self-occupied houses, you have to select any one of the two houses as self-occupied, and the other house/s are treated as deemed to have been let out.
In such a case, you have to offer notional rent for taxation on such deemed to have been let out property and can also claim full interest payable in respect of such house treated as let out.
So, to maximise your tax benefits, it is advisable to treat the property on which interest is lower as self-occupied in case interest payable on any or all of the property is more than Rs. 2 lakh in such cases. The loss under the house property head is allowed to be set off against other income in the same year up to Rs. 2 lakhs in the current year, and the loss not so set off is allowed to be carried forward for set off against house property in eight subsequent years.
For an under-construction property, you can claim interest only from the year when construction of the property is completed, and possession is taken. However, for interest paid during the period before the year of taking possession, the aggregate of such interest can be claimed in five equal instalments beginning from the year of completion of construction.
This is within the limit of Rs. 2 lakhs in case of self-occupied house property. In case you sell the property before completing five years after taking possession, the claim for the remaining years is lost.
Likewise, under the old tax regime, Section 80C allows an individual and an HUF to claim a deduction up to Rs. 1.50 lakh towards principal repayment of a home loan taken for the purchase or construction of a residential house. This deduction is available with other eligible items like life insurance premiums, NSCs, EPF, ELSS and stamp duty and registration charges, etc. This deduction can only be claimed for repayment of a home loan taken from a specified entity, like banks, housing finance companies, etc.
Please note that in case you sell the house, acquired with a home loan, within five years from the end of the year in which possession of the house was taken, all the deductions allowed in earlier years shall be withdrawn and will be treated as income of the year of sale of the property.
If you opt for the new tax regime, no deduction is available for interest for self-occupied property, and for let out property, the deduction is restricted to the net amount of taxable rent, as loss under house property is not allowed to be set off against other income during the same year if you opt for the new tax regime. Deduction for home loan repayment is not available under the new tax regime.
Deductions in respect of education loans
Section 80E allows a deduction for interest paid during the year on an education loan taken for higher education. The law allows you only to claim the interest on the education loan, and no deduction for repayment of the principal amount is allowable. The deduction is available based on the actual payment of interest. So if you pay the interest for earlier years in a single year, you will get the deduction in respect of all the actual interest paid, irrespective of the year to which the interest relates.
The interest deduction can only be claimed for a maximum of eight consecutive years beginning from the year in which you first start paying the interest. If your loan tenure exceeds eight years, you cannot claim the deductions beyond the consecutive period of eight years.
It is therefore advised that you should plan to repay the education loan within eight years. The deduction can only be claimed for an education loan taken for pursuing any government-recognised course after senior secondary examination or HSC, as is popularly known.
Even a part-time course or a diploma course shall also qualify for this deduction if the institution imparting such a course is recognised. The benefit is available only to an individual. You can claim a deduction if the loan has been taken for the study of yourself, your spouse, child or any other child for whom you are a guardian.
It is advisable to claim the benefit of interest for such a loan in the income tax returns of the person who falls in the higher tax slab. The parents can take the benefit of interest deduction in case the interest is agreed to be paid during the continuance of the education. In case the person for whom the loan is taken falls in a higher tax slab, he can pay the interest and claim it in his income tax returns.
Therefore, it is advisable to take an education loan in the joint names of the parent and the student so as to have the flexibility for claiming the interest. The education loan should have been taken from a financial institution or an approved charitable institution. Interest on a loan taken from relatives or friends will not be eligible for this deduction.
Vehicle loan
Generally, no tax benefits are available to a salaried person in respect of any vehicle loan. However, in case the vehicle is used for your business or profession, you can claim the interest in respect of such auto loans as well as the depreciation on the motor car to the extent the same is used for your business purpose. Those running the business of plying taxi can also claim the deduction for auto loan interest.
Personal loan/loan on a credit card, etc.
The income tax, per se, does not allow any tax benefit in respect of any personal loan or loan taken on a credit card. However, in case the personal loan has been used for a purpose like paying margin money for your house or for any business asset and if you are able to establish such usage, the interest so paid can be claimed based on the purpose for which the personal loan was taken has been used.
In my opinion, the benefit for repayment of such a personal loan cannot be claimed under Section 80C, as the money borrowed is not for the specific purpose of buying or constructing a house.
I am sure the above discussion will be useful while borrowing the money for specific purposes.
Balwant Jain is a CA, CS and CFP. He can be reached at jainbalwant@gmail.com, @jainbalwant on X.
