How to use home loan and rental outgo to save income tax

Sanjeev Pandit

Home sweet home, we all say that. All of us wish to own the house we live in. With escalating prices of the real estate, it makes sense to borrow money to acquire the house and pay interest instead of rent.

This is particularly true when one is comparatively young. While the value of the house goes up over the years, the loan liability goes on decreasing with repayment of the loan. With the increased income, the burden of interest and repayment of loan seems lighter.

However, when rentals and real estate prices are stagnant, one should consider if renting a house is a better option. Nonetheless, in the initial years, the burden is heavy and a homeowner wants to lighten it in every possible way. Let us look at ways to do that.

A taxpayer can claim deduction of the amount paid towards repayment of thehome loan from his income. Such loan must have been borrowed from specified entities like the government, bank, LIC, entities engaged in housing finance or specified employers. The limit for this deduction is Rs 1,50,000 along with other eligible payments such as contribution to provident fund, etc.

Once the house is complete and is occupied or rented out, the taxpayer can claim deduction of interest paid on the home loan. Interest paid during the years when the house was under construction, is allowed equally over five years from the year in which house is completed. If the house is self-occupied, the deduction is limited to Rs 2 lakh per year. If the house is given on rent, deduction of the whole of interest is permissible.

In the initial years, often the interest outgo is far higher than the rent received. Till recently, the resultant loss could be adjusted against other income. The law has been changed and now in a year the set-off loss for the year is limited to Rs. 2 lakh and the loss in excess of that is carried forward to be set off in the subsequent 8 years only against income from house property.

It is interesting to note that in the subsequent years if there is sufficient income from house property, there is no restriction on set-off of the quantum of loss that has been brought forward. Once the loan is repaid, the taxpayer may have sufficient property income for setting off the loss.

In order to mitigate the hardship caused by limitation of deduction of the interest or restriction on set off of loss, the taxpayer may consider acquiring the house along with the spouse. In such a case, if both the partners contribute, borrow and make repayment of loan and payment of interest jointly, then each owner will be entitled to claim the deduction towards repayment of loan, payment of interest up to Rs 2 lakh in case of a self-occupied house and set-off loss of Rs 2 lakhs against other income. This is possible where both, husband and wife, have sufficient income.

A taxpayer during the initial years of his career or person having a transferable job may not wish to purchase property and may prefer to rent it. In such a case, if he gets house rent allowance (HRA), he can claim exemption. The exemption is restricted to least of the following (i) actual HRA, (ii) actual rent in excess of 10% of the basic salary and (iii) 50% of the basic salary if taxpayer lives in a metro or 40% of basic salary if in a non-metro city.

A taxpayer not receiving HRA or who is not a salaried employee can claim deduction for the rent paid for his house. For claiming this, the rent paid should exceed 10% of the total income. The deduction is limited to lower of Rs 5,000 per month and 25% of the total income for the year.

If the employer follows ‘cafeteria approach’ where the employee is given freedom to structure his compensation within certain limits, the employee can choose to bifurcate the remuneration appropriately between basic salary, HRA and other allowances to maximise the deduction/exemption available. Sometimes, if the employer takes the house on rent and allots it to the employee as a perquisite, the value of perquisite may work out to be substantially lower.

One must take care to have proper documentation for claiming the deduction/exemption. In some of the states, rental agreements, lease agreements or leave and licence agreements need to be stamped and duly registered. It is advisable to comply with these provisions. While there is no restriction for renting a house from a relative, it is necessary that the arrangement is bonafide. It may be difficult to claim the deduction if you are paying rent to your wife or parents and they are staying with you in the same house.