LTCG Tax on Sale of a Home: Can you add home loan interest to the purchase price of the property to reduce capital gains tax?

Budget 2024 has changed several provisions of the Income Tax Act, 1961. It has amended the income tax brackets under the new tax regime more attractive compared to the old tax regime; increase in the standard deduction in the new tax regime and rationalization of the capital gains tax regime.

Although the new tax regime has become more attractive, many people would hesitate to opt for it as they cannot claim the interest and principal paid on a home loan as a deduction from gross total income before the imposition of tax. They can do so only under the old tax regime.

However, not many taxpayers are aware that income tax rules allow the interest paid on a mortgage loan to be added to the purchase cost of the house for which the loan is taken. This reduces the capital gains made at the time of sale of the house. In addition, one can avail the benefit of indexation (if available under tax laws based on the date of acquisition of the property) on a higher acquisition cost (i.e. the actual purchase cost of the house and the interest paid on the mortgage loan).

However, this benefit of adding mortgage loan interest to the acquisition cost comes with certain conditions.

Mortgage loan interest can be added to the cost of the property subject to the following conditions

The Income Tax Act provides a person with two ways to claim a deduction for interest paid on a mortgage loan.

The first option is to avail Section 24, which allows a deduction from income from home property for the interest paid on the home loan. This deduction can be claimed in the tax year in which the interest on the home loan is actually paid to the lender. Such interest can be claimed as a deduction up to a maximum of Rs 200,000 in a tax year.

The second option is under Section 48, provided the person has not claimed the deduction under Section 24. Section 48 allows the addition of the interest paid on a home loan to the purchase price of the house. The addition of the home loan interest to the purchase price is done to calculate the acquisition cost of the house when it is sold. This acquisition cost is used to calculate the capital gains/losses incurred on the sale. Section 48 does not set a limit on the amount of home loan interest that can be added to the purchase price.

Till March 31, 2023, deduction of interest on the same home loan could be claimed under both sections. However, Budget 2023 has closed this loophole. From April 1, 2023, a taxpayer can claim deduction under either Section 24 or Section 48. The new tax regime does not allow deduction under Section 24 of the Income Tax Act.

The question now arises whether a taxpayer can claim a deduction under Section 48 under the new tax regime when he cannot claim a deduction under Section 24. In simpler terms, since a deduction for home loan interest cannot be claimed under the new tax regime, can a taxpayer add it to the purchase price to reduce capital gains when selling a house?

What tax experts say about reducing capital gains through section 48

There is no consensus among tax experts on whether mortgage loan interest can be added to the purchase cost to calculate capital gains under the new tax regime.

Naveen Wadhwa, Chartered Accountant and Vice President, Research & Advisory, Taxmann.com, says, “Income tax laws do not mention any restrictions for claiming Section 48 deduction if an individual taxpayer has opted for the new tax regime for the financial years in which home loan interest was paid and Section 24 deduction up to Rs 200,000 could not be claimed. Therefore, a taxpayer can claim Section 48 deduction for the financial years in which home loan interest deduction under Section 24 could not be claimed due to the new tax regime.”

Saraswathi Kasturirangan, Partner, Deloitte India, has a similar view. “Budget 2023 has amended the provisions to ensure that any interest on a home loan previously claimed as a deduction against income from home property cannot be included in the acquisition cost for computing capital gains at the time of transfer/sale of the home property. Clearly, this is to avoid double deduction of the same amount. From a practical perspective, individuals (who do not have business income) have the flexibility to switch tax regimes every year, provided they file income tax returns within the due date. If an individual has opted for the new tax regime in certain years and has not claimed the interest paid on the home loan as a deduction against income from home property, such interest can be added to the purchase price of the property while computing capital gain at the time of transfer.” In other words, it is important for taxpayers to keep track of information related to interest costs, as this will affect the calculation of capital gains.”

However, Suresh Surana, a practising chartered accountant, has a different view. “There is no explicit restriction on a taxpayer who has not claimed deduction of mortgage loan interest under section 24 (because of having opted for the new tax regime) being able to claim the same interest as part of the acquisition cost when selling the property. As a general principle, for the purposes of calculating capital gains, both the “acquisition cost” and the “improvement cost” can be deducted and therefore the key question is whether the interest on a mortgage loan can be considered to be in the nature of “acquisition cost” or “improvement cost”. Ordinarily, the interest on a mortgage loan for a property is not considered to be part of the acquisition cost, as claimed under section 24, although in some exceptional rulings it was allowed. It would be advisable to claim interest on a mortgage loan for the purposes of calculating capital gains only to the extent that it can be termed as “acquisition or improvement cost” and has not been claimed as a deduction under section 24. This would generally be the case for interest incurred during the construction period or before acquisition. of the property and not the cost of interest incurred after the acquisition of the property.”

What happens if the entire amount of home loan interest is not claimed as deduction under Section 24?

During the initial years of tenure of a home loan, the interest component in the monthly home loan installment is higher. As time passes, the interest paid on the home loan decreases in the total monthly installment paid and the principal amount increases. Many taxpayers are unable to claim the full benefit of the interest paid in some tax years (usually the initial ones) because Section 24 limits the deduction to Rs 200,000 in a tax year.

If the taxpayer has a self-occupied property, the interest on home loans of more than Rs 200,000 is a loss that cannot be carried forward under income tax rules. If the taxpayer has rented out or is deemed to be rented out the property, the interest on home loans of more than Rs 200,000 can be carried forward. The carried forward losses can be adjusted against future income from home ownership.

The question arises whether a taxpayer can add unclaimed interest paid on a home loan to the cost of purchase under Section 48. In a nutshell, if a taxpayer has paid interest on a home loan of Rs 3.5 lakh in a single financial year and has claimed a deduction of Rs 2 lakh under Section 24, is the remaining interest of Rs 1.5 lakh eligible to be claimed under Section 48 and added to the cost of purchase at the time of selling the property?

Tax experts are also divided on this point. Wadhwa says that “there is no impediment in income tax legislation for taxpayers to add unused interest on mortgage loans to the purchase price, in accordance with section 48.”

Deloitte’s Saraswathi says, “The amended provision provides that any deduction claimed on the interest amount on the home loan will not be included in the cost of acquisition or improvement. Accordingly, any amount of interest not claimed as a deduction in the year of payment can be added to the cost of acquisition or improvement while computing capital gains.”

However, Surana says: “It would be advisable to claim interest on housing loans for the purpose of computing capital gains only to the extent that it can be termed as ‘cost of acquisition or improvement’ and has not been claimed as a deduction under section 24. This would generally be the case for interest incurred during the construction period or before acquisition of the property and not the cost of interest incurred after acquisition of the property.”