How to make the most of the tax benefits available with loans
Education loan and home loan come with income tax benefit. Here are the rules that govern the tax benefits.
“He is poor, his neighbor is poor. How do they manage? They borrow from each other.”
This is one of my favorite quotes and explains the importance of borrowing for each one of us. This article discusses various tax benefits associated with different loans.
Tax benefits for home loans
Under Section 24(b) of the Income Tax Act you can claim deduction for interest on money borrowed for buying, construction or even for repair or reconstruction of a house property. This benefit is available for commercial as well as residential property. Even as per the income tax laws the processing fee and prepayment charges are also treated as interest and eligible for deduction. This deduction is available for any money borrowed whether from banks or friends and relatives, so long as you are able to 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 own residence or it let out. For a let-out property, you can claim full interest but for property used for own residence the deduction is available restricted to Rs. 2 lakh only. If you have more than one self- occupied houses, you have to select one house as self-occupied and the other house/s is treated as let-out. In such case you have to offer notional rent for taxation on such property and can also claim full interest payable in respect of such house treated as let out. So in order to maximize 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.
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 prior to the year of taking possession, the aggregate of such interest can be claimed in five equal installments beginning from year of completion of construction. This is within the limit of Rs. 2 lakh in case of self occupied house property. However in case you sell the property before completing five years after taking possession, the claim for remaining years is lost.
Section 80 C 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 a purchases or construction of a residential house. This deduction is available with other eligible items like life insurance premium, NSCs, EPF, ELSS and stamp duty and registration charges etc.
This deduction can only be claimed for repayment of home loan taken from specified entity like banks, Housing Finance Companies. Etc.
Please note that in case you sell the house, acquired with 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.
Deductions in respect of education loans
The income tax laws allow you to claim full amount of interest paid during the year, on education loan taken for higher education. The law allows you only to claim the interest on education loan and no deduction for repayment of the principal amount is allowable. The deduction is available on the basis of actual payment of interest. Therefore 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 deduction for interest can only be claimed for a maximum of eight consecutive years beginning from the year in which you first start paying the interest. In case you have opted for moratorium during the education period, the eight year period shall start later. However 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 education loan taken for pursuing any government recognized course after senior secondary examination or HSC as is popularly known. Even part- time course or a diploma course shall also qualify for the purpose of claiming interest deduction if the institution imparting such course is recognized.
The benefit is available only to an individual only. You can claim deduction if the loan has been taken for study of yourself, your spouse, child or any other child for whom you are a guardian. However this deduction is not available for education loan taken for your siblings.
It is advisable to claim the benefit of interest for such 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 continuance of the education. In case the person for whom the loan is taken falls in 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 joint names of parent and the student so as to have the flexibility for claiming the interest.
For qualifying the education loan should have been taken either from a financial institution or any approved charitable institution. Interest on loan taken from relatives or friends will not be eligible for this deduction. The first category covers all the banks including cooperative banks, one non banking institution HDFC Ltd. (Credila) is also approved by the government for this purpose. There is another category of institutions which includes charitable institutions and NGOs, from where education loans can be taken to qualify for tax benefit on interest.
Generally no tax benefits are available to a salaried person in respect of any car loan. However in case the vehicle for which the loan is taken is used for the purpose of your business or profession, you can claim the interest in respect of such auto loans as well as the deprecation on the motor car to the extent the same is used for your business purpose.
Personal Loan/loan on credit card etc.
The income tax per se does not allow any tax benefit in respect of any personal loan or loan taken on credit card. However in case the personal loan taken has been used for a purpose like paying for 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 taken has been used. However in my opinion, the benefit for repayment of such personal loan cannot be claimed under Section 80 C as the money bowered is not for 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 CA, CS and CFP. Presently working as Company Secretary with Bombay Oxygen corporation Limited, View are his personal. He can be reached at firstname.lastname@example.org, @jainbalwant