Loans are generally assumed to be a risky liability as the generally individuals avail loans more than what they can bear. A loan, by itself, is never risky; it is only by the improper utilization and improper budgeting, the problem starts.
An individual perhaps forgets that the way he wishes to earn interest on his investments, he also has to pay interest on his liabilities.
Loans availed can be judiciously used also to save taxes in an efficient manner. Some of the tools are:
Interest portion of home loan
The first and the foremost tax sop is the interest amount that you pay on housing loans. The interest on housing loans in the initial years is the major component of the EMI you pay. The interest may exceed the rental income from house property, resulting in loss from house property.
The interest payable (accrued and not paid) of a home loan is eligible for deduction under section 24(b) of the income tax act as “interest on borrowed capital”. The interest deduction is Rs 1,50,000 (if the loan/property acquired after 01.04.1999) for a self occupied property. For let out property/deemed let out property, the actual accrued interest is deductible without any limits.
Principal portion of home loan
The principal portion of a home loan is eligible for deduction under section 80C of the income tax act. The criteria being, the assesee has to obtain a loan from an eligible financial institution/bank and the proceeds has to be used for the construction/purchase of a house property, which is subject to income from house properties. The maximum amount of deduction is Rs 1,00,000 under section 80C. But the deduction will be taxable in case the property is sold within 5 years from the date of construction/purchase.
- The house property shall be registered in the name of the person, who intends to claim deduction towards interest and installment.
- In the case of working couples having substantial taxable incomes, it may be worthwhile to register the housing property in the joint names and take separate housing loans to claim deduction of interest and installments.
- The EMIs may be planned in such a way that the payments towards principal part of the loan do not exceed the limits available u/s 80C.
Interest portion of education loans
Section 80E of the income tax act provides for deduction in respect of repayment of the loan taken for higher studies. For the deduction, the individual should take a loan from a financial institution or any approved charitable institution. Secondly, the loan should be taken for higher education and for the assessee himself.
However, higher education means full time course for graduate or post-graduate courses in select fields. The amount eligible for deduction is the entire interest amount. The deduction is available for eight assessment years starting from the assessment year in which the assessee starts paying the interest on loan, or until the interest is repaid in full, whichever is earlier.
While individuals lose sleep over paying the EMI’s after availing a loan, seldom they know that the loan can be used as an effective tool to reduce tax.
Considering a hypothetical example,
Total principal paid during the year – Rs 3,00,000
Total interest paid during the year – Rs 1,70,000
Interest on education loan – Rs 30,000
The total maximum deduction available will be Rs 2,80,000. Assuming the assessee is taxed at the maximum marginal rate i.e. 33.99%, a tax outflow of Rs 95,170 is saved.
Thus, loans can do more good than bas if utilized judiciously. Living without loans is tough, so utilize it effectively while you can!
The author is a Certified Financial Planner, working as Senior Manager with Mumbai-based SRE Financial Planners.