Under Construction Property: Tax Implications

My friend 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.

Though the deduction is available under Section 80 C (xviii) for the purposes of purchase or construction 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.

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.

Section 24 of the Income Tax Act states that no deduction is permissible on interest payment during the years in which construction of the property is still to be completed. Interest for pre-construction period is eligible for deduction in 5 equal installments (across 5 years) from the year construction is completed.

A close look at clause (xviii) stated above suggests that for the principal repayment to be considered for tax rebate under Section 80C, there should be an income (or notional income) from the house property. When a property is under construction, there is no likelihood of income, and hence under Section 80C there is no provision for tax rebate on account of principal repayment. Only in the year in which the construction is completed can the principal repayment be considered for tax rebate.

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 80 C 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.