As home ownership continues to be one of the key life decisions for most Indians, negotiating the price and ensuring complete paperwork assumes a lot of importance. It is equally important to maximise the tax benefits from investments in residential property.

Asset creation and tax savings

Due to the high stakes involved, several tax aspects need to be considered while purchasing and selling a residential property. While evaluating the cost of funding the acquisition, the end use of the property should be kept in mind as it could have significant tax implications. For a self-occupied property, a deduction of Rs 30,000 per annum is available for interest payable. However, an enhanced deduction of up to Rs 2 lakh per annum for a self-occupied property can be availed of if acquisition or construction of the property is completed within three years from the end of the year in which the loan is taken.

For a let-out property, the post-tax interest cost could be lower as the entire amount of interest can be taken as a deduction while computing taxable income. Where the deduction of interest is higher, the excess is treated as loss that can be set off against other income, or carried forward to the subsequent year.

For an under-construction property, interest deduction would not be allowed from taxable income until the construction is complete. But aggregate interest paid on the home loan during the period prior to completion of construction can be claimed as deduction in five equal instalments starting with the year of completion.

All co-owners are entitled to tax benefits, provided they are co-borrowers too. Apart from interest, deduction from taxable income can be claimed towards repayment of principal amount on a home loan and stamp duty, registration fee, etc., incurred in the purchase of a house up to a maximum of R1.5 lakh, subject to certain conditions.
Sale of property

The seller makes a capital gain, which is taxed, or it can be reinvested in specific assets or schemes. Timing the sale is crucial as it can make a big difference to the tax burden. The value on which capital gains is to be computed is the differential amount between the sale price and the initial purchase price, cost of additions or renovation (if capital in nature) and the transfer costs.

If the property is sold within three years of acquisition, the asset is considered to be short-term capital asset (STCA) and is taxed as per the slab rates. Subject to commercial considerations, it would be beneficial from a tax perspective if the property is held for more than three years. Accordingly, the property would be considered to be long-term capital asset (LTCA), resulting in long-term capital gains (LTCG), which is taxed at a concessional rate of 20%.

A potentially greater tax benefit while computing LTCG is the cost-inflation index, which is applied to the cost of the property to factor in the impact of inflation on the cost. Let’s say a property is purchased in 2001-02 (index of 426) for Rs 5 lakh and sold in 2014-15 (index of 1,024) for Rs 50 lakh. Then, the indexed cost of purchase will be considered to be Rs 12 lakh, which will reduce the resultant tax outgo by Rs 1.4 lakh.

While an under-construction property cannot be treated as a residential property for tax purposes, it may be possible to construe such a right as a ‘capital asset’. Such a right could be STCA or LTCA depending on the period of holding. If such a right is sold after completion of construction, it would be taxed as STCA/LTCA depending on several factors, which should be considered carefully based on judicial precedents.

LTCG exemption

Tax exemption is provided on reinvestment of sale proceeds of a house /LTCA into a new house. The condition is that the new property should be constructed within three years from the sale of the original property or purchased either one year before or two years after sale. The amount of exemption would be lower of (a) capital gain or (b) investment made (reinvestment of sale proceeds of house) or proportionate amount invested in relation to net sale consideration (reinvestment of LTCA), subject to conditions.