Under Construction Property: Tax Implications

My friend Dhanpat Bafna purchased an under construction property in 2009.
He happily went ahead with making his tax deduction claim under section 80 C with respect to loan repayment during the period when the property was under construction. A shocker awaited him as he was not entitled for the same.

Like Bafna, there are many others who may face this situation.

So what is the tax implication here?

Though the deduction is available under Section 80 C in respect of repayment of loan taken for the purpose of construction of a house property, the eligibility to claim such deduction happens only when this property becomes a house property and income from which is chargeable to tax under the head “Income from house property”.

The income in respect of any under construction property does not become taxable under the head income from house property immediately on your booking the property or commencing the construction. This only will become taxable when the assessee becomes owner of the property as defined in Section 27 of the Income Tax Act.

Ownership of the property is important

For the purpose of taxing any property under the head “Income from House Property”, it is essential that the person should be owner of the property. Before the actual possession of the property is given, what you own is the right to acquire the property by virtue of having booked the under construction property. Under the provisions of the Income Tax Act, even if possession is given to you before transfer of actual ownership, you are treated as owner for the purpose of house property income.

Few builders and bankers are luring the prospective buyers into availing full or substantial portion of the loan in respect of the under construction property assuring them that they will be entitled to claim tax benefits in respect of the repayment of the loan made to the lender bank while the property is still being constructed. But this is not true.

Lets illustrates this with Mr. Bafna’s example:

Mr. Dhanpat Bafna booked a flat on 1st January 2009 by paying the token money. Later on he obtained home loan from a bank for Rs. 50 lacs and got it disbursed directly to the builder, as he had already obtained the full loan from the bank. Accordingly the bank started his EMI of Rs. 50000 from April 2009. He obtained the possession of the property in June 2010. During the period of April 2009 to March 2010 i.e. the period during which he was paying his EMI but did not have possession of the property, he had already paid an amount of Rs. 6 lacs in EMIs which comprised Rs. 5 lacs of interest component and Rs. 1 lac of principal component. .

Tax impact of the EMI paid before taking the possession:

Let us understand the implication. The amount of Rs. 1 lac paid by Mr. Bafna, till the date of his taking over the possession, towards repayment of the loan will not be eligible for any tax benefits whatsoever. The benefits in respect of home loan repayment during the construction period of the property have been lost for good.

However in respect of interest payment of Rs. 5 lacs made by Mr. Bafna before the year in which he became owner of the property, he will not get any deduction during the period when the construction went on. He will be able to claim in respect of interest paid during construction from the year of his taking over the possession. The deduction available to him will be 1/5 of the total interest paid during the construction period i.e. amount of Rs. 1 lac for five years beginning with the year of taking the possession or completion of the construction.

This tax benefits can be claimed together with the interest payable for the relevant year within the overall limits applicable. The limit in respect of self occupied property is Rs. 1.50 lac per year. However he can claim full interest together with 1/5 portion of interest paid prior to his taking over the possession if the property is let out.

It may be noted that Mr. Bafna will be able to get full deduction for interest paid during the year in which he becomes the owner of the property even though the part of the interest may relate to the period during which the property was under construction.

However, same conditions do not apply in case of deduction in respect of repayment of the housing loan during for year in which he actually gets the possession. The eligibility for deduction in respect of principal repayment begins from the date on which he takes possession of the property.

From the above discussion it becomes clear that in case you have repaid any principal component before taking possession of the property, the same will not be available for any tax benefits. However in respect of interest paid prior to the year of taking the possession, you will be able to claim the deduction in five equal installments beginning from the year you take possession of the property.

Please take into account these factors before you opt for substantial disbursement of the loans amount, where payment of Home loan EMI begins before completion of construction of the house property.

Also note that in case you sell such property before its completion, you loose your entitlement to claim 1/5 of the interest paid during construction period forever.
In case you sell the under construction property within five years after taking over the possession, there are two implications. Firstly you loose the right to claim your 1/5 installment of pre-EMI interest for remaining years. Second all the benefits availed by you towards repayment of the principal of housing loans under Section 80C after you have taken possession will be added to your income and taxed in the year of sale of the property.

Thus do not get lured by the assurance from the builder or the bank that you will get full deductions for principal repayment in for the said period.