In the case of an under-construction property, the deduction on interest can be claimed only after the construction is complete. Moreover, there are caps on the maximum interest that can be claimed depending on whether the property is bought for renting out or self-consumption. These rules significantly restrict the total deduction the homeowner can claim.
Home loan deduction rules
Under Section 24(b) of the Income Tax Act, borrowers can claim a deduction on the interest component of their home loan. For a self-occupied property, the annual limit is ₹2 lakh. It should be noted that the deduction on self-occupied property is allowed only under the old regime.
For a house that is rented out or deemed to be let out, there is no upper limit on interest deduction, and it’s allowed under both regimes.
This deduction softens the burden of the loan EMI, especially in the early years when interest forms the bulk of each payment. In theory, this creates a compelling advantage. Even on a self-occupied house, a person in the highest tax bracket who claims the full ₹2 lakh deduction saves ₹60,000 in taxes each year. Over a decade, the savings can exceed ₹6 lakh, improving the effective return on the property and lowering the cost of borrowing. The savings can be far higher for a rented-out property.
But the tax benefit applies only when the property is complete and occupied. With under-construction properties, the rules are different, which can significantly alter the final outcome.
Different rules for under-construction purchases
The tax laws don’t allow interest deduction to be claimed while the property is under construction. The interest paid up to the financial year preceding completion is accumulated and classified as pre-construction interest. “The interest deduction under Section 24(b) starts only from the year in which the construction is completed. Any interest paid during the construction period is accumulated and claimed in five equal instalments beginning from the year of completion,” said Vijaykumar Puri, partner at VPRP & Co LLP, Chartered Accountants.
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However, there are two-fold restrictions on deduction that can be claimed if the house is self-occupied. First, a ₹2 lakh annual cap applies to the total interest claimed in a year. The pre-construction instalment plus the current-year interest must fit within this overall limit. Any amount exceeding ₹2 lakh is lost.
Consider a borrower who pays ₹10 lakh in interest during four years of construction. This becomes pre-construction interest, and the annual deduction that can be claimed is ₹2.5 lakh. If the current-year interest after possession is another ₹2 lakh, the total interest eligible for deduction is ₹4.5 lakh. Against this, the borrower can claim only ₹2 lakh for a self-occupied house–more than half the interest deduction is lost.
Second, when construction drags beyond five years from the end of the financial year in which the loan was taken, the situation becomes even less favourable. In such cases, the annual deduction for a self-occupied house collapses from ₹2 lakh to ₹30,000.
The structure of home loan interest amortization makes the problem sharper. “If the possession happens after five years, the homeowner can claim only up to ₹30,000 of the accumulated interest per year for five years. This would mean you can deduct only ₹1.5 lakh of the accumulated interest, even if it’s higher. This can hurt homeowners as the interest in the initial years of loan repayment would definitely be much higher for a home loan,” said Suraj Nahar, a Jamnagar-based CA.
In the above example, say the construction took seven years and the accumulated interest is ₹14 lakh. But you can only claim ₹1.5 lakh over five years, while the remaining ₹12.5 lakh is written off completely. In the case of apartments bought from builders, it’s not uncommon to receive possession beyond five years.
For let-out or deemed-to-be let-out properties, there are no such caps on the interest deduction itself. The homeowner can claim full interest even if the construction is completed after five years, and the full pre-construction instalment can be deducted, even if it exceeds ₹2 lakh annually. Deductions are allowed under both regimes. “However, the overall set-off of all house property losses against other income in a year is limited to ₹2 lakh,” said Puri.
Losses arise under ‘income from house property’ head in the income tax return. One has to declare the rent under this, and it can be deducted from the interest paid on the loan in that year. If the interest paid is higher than the rent, it results in a loss that can be set off against any other income, but up to ₹2 lakh. This ₹2 lakh limit restricts the extent of tax benefit on rented out property, even if full deduction on interest is allowed.
Nahar said tax laws may appear favourable to rented properties, but the ₹2 lakh limit on loss set-off places a similar restriction on them. “For self-occupied homes, which do not generate income, the cap prevents homeowners from artificially reducing taxable income by taking very large loans. For rented properties, full interest deduction is permitted, but the set-off restriction ensures that taxpayers cannot exploit large interest outflows to eliminate tax liability on salary or business income. Besides, in the new regime, loss can only be set off with rental income and carrying forward remaining losses is not allowed,” he said.
Investment in under-construction house
For homebuyers who treat a loan as financial leverage, these restrictions on under-construction properties can undo the very advantage they were counting on.
A home loan provides a real tax advantage only when you can claim the full interest deduction each year. For example, if you take a ₹50 lakh loan at 9% for 25 years on a ready-to-move-in house, the first-year interest is ₹4.47 lakh. Claiming a ₹2 lakh deduction in the 30% tax slab saves you ₹60,000 in tax. This effectively reduces your interest burden to ₹3.87 lakh bringing the true interest rate down to about 7.8%.
Now, say you take the same ₹50 lakh loan for an under-construction home where the project takes six years to complete. The rules become different. Since possession is delayed beyond five years, accumulated interest can be claimed only at ₹30,000 per year for five years, totalling ₹1.5 lakh. The remaining ₹24 lakh is permanently disallowed. Even after possession, the annual deduction is limited.
As a result, you end up paying nearly the full interest each year with almost no tax relief, and the effective interest rate stays close to 9%. “The leverage disappears in under-construction properties due to deferred deductions and annual caps,” says Suraj Nahar.
Although tax rules allow any unclaimed home loan interest to be added to the property’s cost of acquisition, the benefit is not immediate–it is realised only when you eventually sell the house. Prakash Hegde, a Bangalore-based CA points out that the tax advantage is also much smaller. “When you claim interest as a deduction each year, those in the higher tax slabs save 30% tax. But when the same amount is added to the cost of acquisition, the tax saving on sale works out to only 12.5%.”
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