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14 tax tricks and traps when buying property

September 04, 2008

With incomes rising, property and home purchases have grown exponentially in recent years. Being large-ticket investments, it's important to be savvy about the tax breaks and pitfalls that lie en-route.

1. Cancellation of contract by buyer

The courts have held that any advance, earnest money, part payment or any other sum paid by a prospective buyer to a prospective seller for the purchase of capital asset is not an income. The character of such a payment cannot change simply because the seller decides to confiscate it for non-performance by the buyer.

Since no transfer of any capital asset has actually taken place, there is no capital gain for the seller. Though it is a pecuniary loss for the buyer, he would not be able to claim it as a capital loss under Section 45 of the Income Tax Act as the prospective buyer neither ever owned nor relinquished the capital asset in question.

This means that the entire forfeited amount escapes the tax net, but only in the present dimension. When the property is eventually sold, Section 51 stipulates that in computing cost of acquisition, any advance or other money received and forfeited by the assessee is to be deducted from the cost or the written down or fair market value, for which the asset was acquired.

2. Buying a house in spouse's name using your money

Purchasing a house in the name of your wife by applying your own funds means that you are using her as a name-lender and this amounts to a 'benami' transaction, which is illegal. The house squarely belongs to you and you will have to treat it as such.

The transaction can be made legal by gifting the money to the wife to enable her purchase the property in her name. Another alternative is to gift your house to her, but this will attract stamp duty and registration charges. It is also necessary for you to follow the procedure for gifting. There is no sense in taking either of the actions in most of the situations.

The utility, if any, is lost because of the clubbing provision, which requires the property income to be added to your income for income tax and its value to be added to your wealth for wealth tax.

If you take a housing loan in your name, you would not be able to claim any tax benefits associated with the loan, because the house belongs to your wife.

In short, do not buy a house property (or any other asset) in the name of your spouse. The tax concessions on housing loan can be availed only by the person who owns the house.

3. Loan taken prior to acquisition of house

Both the deductions u/s 24 and 80C are allowed only when the income from house property becomes chargeable to tax. In other words, the construction should be complete, the flat should be ready for occupation and the municipal annual value should be known. The interest for the years prior to the year in which the property was completed, shall be deducted in equal installments for the year during which it was completed and each of the 4 immediately succeeding years.

Unfortunately, there is no corresponding provision for deduction u/s 80C for capital repayment.

Thus, protracted delays by a builder end up unfairly punishing the assessee. Beware.

4. Taking a loan to repay an earlier loan may be beneficial

If you find that it is quite beneficial to borrow funds for the express purpose of repaying the old loan, go ahead. Loan taken from a permissible source to extinguish loan from another permissible source, qualifies for deduction (Circular 28 dated 20.8.69).

The following is the relevant part of the Circular:

"If the second borrowing has really been used merely to repay the original loan and this fact is proved to the satisfaction of the Income Tax Officer, the interest paid on the second loan would also be allowed as a deduction u/s 24(1vi)."

This gives rise to two issues:

  • The interest on the second loan continues to get the benefit of the deduction u/s 24. Unfortunately the deduction u/s 80C is not available. Illogical? But that's how it is.
  • Suppose, the first loan is taken before 1.4.99 and the second after that date. Does the ceiling on interest deduction go up from Rs. 30,000 to Rs. 1,50,000? Logically, since the 2nd loan maintains the continuity and does not change the colour and character of the 1st loan, the deduction should stay put at Rs. 30,000. Some of the housing finance companies push their products claiming that the 2nd loan gives the borrower the right to claim higher deductions.

5. Second loan for a second flat

Suppose an assessee has taken a flat through housing loan and is claiming deduction on interest and also on repayment of loan. Subsequently, he takes a second flat and also takes a loan for its purchase. This second house will be treated as let out or deemed let out. The entire interest payable without any ceiling is deductible against the income from it. Even if he does not let it out, the annual value of the flat will be treated as income for income-tax purpose.

One more point. Even if two loans are taken for the same flat, total benefit can be claimed on both the loans as long as both the loans are for acquisition or construction.

6. Joint loans

In case of joint holding, both the holders will be able to claim 100 per centĀ of the concessions separately, if and only if, their individual share in the property and also in the loan is defined and ascertainable.

Unfortunately, housing loans are not normally granted to those who go in for flat in joint names. In the case of default, it is easy to deal with property entirely belonging to the defaulter. Joint ownership is riddled with legal hassles. When one defaults and the other does not, it is impossible to evict both of them. Two separate loans are also riddled with the same problem.

7. Tax breaks on self-occupied and let-out properties

The entire interest on loans taken is admissible when the property is not self-occupied whereas the deduction for self-occupied property is restricted to Rs. 30,000 or Rs. 1,50,000.

8. Interest on housing loans deductible on accrual basis

Sec. 24(b) allows deduction of interest payable on borrowed capital. The deduction is allowed even if the interest is not paid and even if the borrower is in default. Illogical, but that's how it is!

9. Loan taken after acquisition of a property

Loan taken after taking possession of the house is obviously not taken for purchasing the house. Hence it will not attract any tax benefits associated with housing loans.

10. Land and superstructure can be valued separately for capital gains

The definition of a capital asset includes property of any kind and land held by the assessee is a capital asset and a building held by the assessee is also a capital asset. Suppose the land is held for more than 3 years and the superstructure is of recent origin.

It is not possible to say that by construction of the building, the land, which was a long-term capital asset, has ceased to be a long-term capital asset, and it continues to remain as an identifiable capital asset even after construction. The courts have held that the land and the superstructure can then be assessed separately as 'long term capital asset' and as 'short term capital asset', respectively, for the purpose of capital gain.

One important aspect: Suppose the superstructure belongs to one person and land to another. When the house is sold, the exemption on capital gains can be claimed only u/s 54F and not u/s 54. Sec. 54 is applicable only to houses and neither the land nor the superstructure separately can be regarded as a house.

Therefore, for the purpose of claiming the benefit of housing loan, it would be difficult to claim any deduction on interest payable or capital repayment, where the land belongs to wife and the superstructure belongs to husband.

This difficulty can be bypassed by the wife giving the land to the husband on lease or by selling it to him.

11. Administrative charges and processing fees

The repayment of loan is eligible for deduction u/s 80C and interest payable thereon is deductible u/s 24. Some housing finance companies build up their initial charges into the EMI in which case, the tax benefits are available. If the company makes you pay a lump sum towards the administrative and processing charges, no tax benefit is possible as these are neither a repayment nor interest.

12. Difference between purchase and construction

Sec. 54 gives exemption from tax on long-term capital gains arising out of sale (or transfer) of a residential house, self-occupied or not, provided the assessee has purchased within 1 year before or 2 years after the date of sale or has constructed a residential house within 3 years after that date.

Note that the exemption is available on purchase of new property made within 1 year before the sale of the old house. But in the case of construction, the exemption is not available if the construction is completed even 1 day before the sale of the old house. Illogical!

13. Dates of registration and acquisition

Normally, the title to an immovable asset does not pass till conveyance deed is executed and registered. However, in a landmark judgement, the courts held that "taking into consideration the letter as well as the spirit of Sec. 54 and the word 'towards' used before the word 'purchase' in Sec. 54, it is clear that the said word is not used in the sense of legal transfer and, therefore, the holding of a legal title within a period of one year is not a condition precedent for attracting Sec. 54."

Thus, even if the documents are not registered but the following conditions of Section 53A of the Transfer of Property Act are satisfied, ownership in the property is held to have been "transferred" -

  • (a) there should be a contract in writing;
  • (b) the transferee has paid consideration or is willing to perform his part of the contract; and
  • (c) the transferee should have taken possession of the property.

When these conditions are satisfied, the transaction will constitute "transfer" for the purpose of capital gains.

14. Loss from house property

The treatment for loss from house property has a drawback. Suppose the normal income is Rs. 1,62,000 and the loss from the property is Rs 20,000. The total net income works out at Rs 142,000. This being less than Rs 150,000, the minimum tax threshold, no tax is payable.

In effect, only Rs 12,000 of the loss is useful for reaching the threshold. The rest of the loss of Rs 8,000 is wasted as it is not allowed to be carried forward!! This is so, because Rs 8,000 does not remain a loss but becomes a gap between the tax threshold and the income.

On the other hand, if the total income were Rs 15,000, then the assessee would be allowed to carry forward the loss of Rs 5,000. If the total income were nil, the entire loss of Rs 20,000 could be carried forward to next year. Such carried forward loss can be adjusted only against income from house property.

(Excerpt from Taxpayer to Taxsaver (FY 2008-09) by A. N. Shanbhag and Sandeep Shanbhag, published by Vision Books.)

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