Budget provisions that will discourage investment in high-value homes

In the Union Budget 2017-18, the finance minister has proposed that the loss under the head ‘Income from house property’ can only be adjusted to the extent of Rs 2 lakhs. We examine the impact of this move on the income tax outgo of individuals

The Union Budget 2017-18 has proposed some provisions, which will boost the affordable housing sector but at the same time, will discourage tax payers from treating real estate as an investment class. One such proposal will adversely impact investment in high-value properties or more than one property.

At present, the income tax laws allow you to claim interest paid for purchase/construction/repairs/renovation of your house property. This deduction is restricted to Rs 2 lakhs, in case the house is self-occupied. In case the property is let-out, presently, there is no such limit and you can claim the full interest paid on money borrowed for the let-out house, including the interest paid during construction of the house. In case of more than one self-occupied house property, you have an option to choose any one of the properties as self-occupied and the other property/ies shall be treated as let-out and accordingly, you are entitled for full interest claim in respect of money borrowed for such property/ies.

As the annual value of the self-occupied property is taken as ‘nil’ and as the rent received from the let-out properties are far lower than the interest paid on the home loan for it, the income under the head ‘Income from house property’ is generally a loss, which you are allowed to set off against your salary income, in case you are a salaried person and against business/profession income, in case you are self-employed. This provision of deductibility of interest on home loan, is generally used by tax payers in the high tax brackets, to reduce the ultimate tax liability, as the negative income under the head ‘Income from house property’ helps you to reduce your taxable income.

The finance minister has proposed that the loss under this head, can only be adjusted to the extent of Rs 2 lakhs against your other income and the balance shall have to be carried forward for set-off, in the subsequent years against house property income. Hence, as long as you continue to service the home loan, you will not have any positive income in the subsequent years and therefore, this provisions of letting you carry forward the excess interest beyond Rs 2 lakhs, is superfluous.

 

Impact of the proposed amendment on tax payers, who have taken huge loans or have bought more than one house with borrowed money

To be able to fully claim the interest of Rs 2 lakhs, in present circumstance with an interest rate of 9%, the money borrowed should not exceed Rs 22.22 lakhs. So, anybody who has borrowed more than 22.22 lakhs, will invariably have to pay an interest of more than Rs 2 lakhs and will not be able to set off any interest beyond the limit of Rs 2 lakhs.

In a metro city like Mumbai, it is often impossible to buy a 1-BHK house below the cost of Rs 1 crore. Considering that the buyer has to shell out the margin money of 20%, he will have to borrow Rs 80 lakhs, which is far beyond the limit of Rs 22.22 lakhs. With a loan of Rs 80 lakhs, the interest outgo will be around Rs 7.20 lakhs. Hence, interest of Rs 5.2 lakhs will not be eligible for tax benefits. Moreover, even a house of this size may be insufficient for a person having a family of two children and parents. Thus, people in these cities will have to borrow higher money and pay interest on this money to own a respectable-sized house.

See also: Budget 2017 analysis: Experts believe middle-class home buyers have been ignored

 

Impact of proposed amendment on interest on home loan

The example below illustrates the impact on your tax liability on various interest outgo over Rs 2 lakhs

Income slab Rs 5-10 lakhs Rs 10-50 lakhs Rs 50 lakhs to 1 crore
Effective tax rate 20.60% 30.90% 33.99%
Interest outgo (in Rs lakhs) Excess interest (in Rs lakhs) Change in tax liability (in Rs lakhs)
5 3 0.62 0.93 1.02
10 8 1.65 2.47 2.72
15 13 2.68 4.02 4.42
20 18 3.71 5.56 6.12
25 23 4.74 7.11 7.82
30 28 5.77 8.65 9.52
50 48 9.89 14.83 16.32

 

From the above table it is apparent that for a person who is paying an interest of Rs 5 lakhs (assuming an interest rate of 9% on a loan of Rs 55 lakhs), his tax outgo will increase by 0.62 lakhs to 1.02 lakhs, depending on his tax slab. For a person who has taken a higher home loan (of Rs 5.55 crores) and with interest liability outgo of Rs 50 lakhs, his tax liability will go up by Rs 16.32 lakhs in case his income is in the highest tax slab.

Presently, there is not limit up to which you can claim set off of interest paid on home loan, for any number of homes, including the limit of Rs 2 lakhs for one self-occupied house. However, the budget proposes to set an overall limit of Rs 2 lakhs, including the limit for one self-occupied house property. This provision will surely adversely affect those who wish to borrow money for a second house, with an existing home loan running. With tax arbitrage no longer available, many tax payers will have second thoughts, on whether to continue to remain invested in the second house or to dispose it. This provision will, to some extent, bring some high value properties into the market for sale.

The time may now be ripe, to set different limits of allowance on interest for home loan, depending on the geographical location of the property, looking at the vast variance between housing prices in metro cities and in small towns. The government should also think of revising the limit for one self-occupied house property, to ensure housing for all.

(The author is a taxation and home finance expert, with 30 years’ experience)

 

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