Many prospective homeowners are currently facing a situation where they have not received possession of the flats, which are under construction and which they booked many years ago. But according to the agreement with the builder, they were to receive possession long ago. In these cases, the construction is either held up or is still in progress. Not only are such prospective homeowners denied the benefits of staying in their own homes, but they also suffer on the income tax front.

Under the Income-tax Act, 1961, a taxpayer gets a deduction of Rs.2 lakh (if this is his only home) in respect of interest paid on housing loan taken to acquire the house. However, such interest is allowed as a deduction only if the house belongs to the taxpayer during the year. This would mean that the house is complete and possession has been taken by the taxpayer. If the house is not complete or possession has not been taken, then the interest paid for the year on the home loan is not deductible and cannot be adjusted against other income for the year.

However, such interest can be accumulated till the year in which possession of the house is taken after completion of construction. One-fifth of such construction period interest will be allowed each year for five years from that year along with the interest of that relevant year. Further, the limit of Rs.2 lakh will operate as a combined limit for the interest of that year plus one-fifth of the construction period interest. Therefore, any delay in receipt of possession or completion of construction of a house results in an increase in the construction period interest, with a greater likelihood of a part of such interest not being allowed for tax deduction on account of the Rs.2 lakh limit in the subsequent year of deductibility.

There is one more aspect to the deductibility of such interest. The normal annual limit for deduction of housing loan interest is actually only Rs.30,000. This limit gets enhanced to Rs.2 lakh if the acquisition or construction of the house is completed within three years from the end of the financial year in which the capital was borrowed for acquisition of the house. Therefore, if the possession of the house is received more than three years from the end of the financial year in which the housing loan was taken, then only interest of Rs.30,000 is deductible each year, and not Rs.2 lakh.

Take an example where a housing loan of Rs.50 lakh was taken in September 2011, but possession of the house was received in May 2015. In such a case, since possession was not received within three years from March 2012, being the end of the financial year in which the loan was taken, the interest on the housing loan deductible from the financial year 2015-16 would be only Rs.30,000.

What happens where the loan was disbursed in instalments, and only a part of the loan was disbursed beyond the three-year time limit? The tax laws use the term “capital borrowed”. This would imply that the loan was actually utilized, i.e., disbursed, and not merely sanctioned. At the time of sanction, it cannot be said that capital has been borrowed. Therefore, in this situation, the property has been acquired or constructed partly with capital borrowed beyond the three-year time limit, and partly with capital borrowed within the three-year time limit. If the substantial part of the loan disbursement is within the three-year time limit, then it would amount to a substantial compliance with the requirements of the law. The better view would, therefore, be that, in such a situation, the borrower should be able to get the benefit of the Rs.2 lakh limit, and not be restricted to the Rs.30,000 limit.

There is one more effect of delayed construction or possession of the house. Under sections 54 and 54F, exemption for long-term capital gains is available if the capital gains or the net sale proceeds are reinvested in the purchase of a residential house within a period of two years from the date of sale of the capital asset or within a period of three years in construction of a residential house. Acquiring an under-construction house from a developer has been held to amount to construction of a house and not purchase of a house by various high courts, and, therefore, the time limit of three years applies to such acquisition. If the construction is not completed and possession not given by the developer within the three-year period from the date of transfer of the capital asset, tax authorities tend to take the view that the taxpayer is not entitled to the benefit of the exemption for reinvestment of capital gains in a residential house.

High courts have, however, taken the view that where a house purchaser has agreed to purchase a house under construction, has fulfilled his requirements under the agreement, including making all payments due by him, but where he has not been able to obtain possession due to default on the part of the developer, the capital gains provisions have to be interpreted in a beneficial manner. In such a case, according to the courts, the benefit of the exemption cannot be denied to the house purchaser. The tax authorities, however, do not subscribe to this view. Therefore, though legally one may be able to get the benefit of the exemption in spite of the delayed possession, the issue would in all likelihood be subject to litigation with the tax authorities.

Therefore, delay in possession of an under-construction house could have significant negative tax consequences for a taxpayer, who has either taken a loan for acquisition of the house or who is seeking the benefit of long-term capital gains tax exemption. For such taxpayers, acquiring a ready house with immediate possession is a much safer proposition.