Clipped from: https://taxguru.in/income-tax/interest-home-loan-added-cost-acquisition-computing-capital-gains.html
Author’s Note
A client came to me as he wanted to sell his first residential building, which he had bought five years back, to relocate to a new city. His tax filer had made him pay around Rs. 15 lakhs in tax; hence, he approached me seeking advisory and tax-saving techniques, as he had also failed to make any investment of the sale proceeds. I provided him with advisory support and saved approximately Rs. 5 lakhs in taxes. How? Let’s discuss this in the article, along with a few case laws and the research I have done.
Introduction
Most people are confused about whether, while computing capital gains on the sale of immovable property, interest paid on a home loan can be added to the cost of acquisition so as to reduce the taxable capital gain, or whether it is disallowed. This issue arises because the Income-tax Act allows deduction of home loan interest under Section 24(b) on one hand, and permits reduction of the cost of acquisition and improvement under Section 48 while computing capital gains on the other.
In this article, I have briefly explained the same. Before that, let’s discuss the sections that I will be using in this article.
Section 48 deals with mode of computation:
“The income chargeable under the head ‘Capital gains’ shall be computed by deducting from the full value of the consideration … (ii) the cost of acquisition of the asset and the cost of any improvement thereto … Provided that the cost of acquisition of the asset or the cost of improvement thereto shall not include the deductions claimed on the amount of interest under clause (b) of section 24 or under the provisions of Chapter VIA.” (Inserted proviso effective AY 2024-25)
This means that section 48 lays down how the capital gains are computed, i.e. by reducing from sale proceeds the cost of acquisition and cost of improvement. This new proviso stops taxpayer from claiming double benefit, that means if the assessee have already taken a deduction for interest as per section 24(b) or Chapter VI-A, then he cannot again add that interest to cost of acquisition/improvement to reduce capital gains, I think it’s fair enough, but what is this section 24(b) of income tax act?
Section 24(b) deals with interest on borrowed capital by permitting the deduction from income from house property for interest payable on borrowed capital used for acquisition or construction or repair or renewal which is subject to the statutory limits, that means in the case of a self-occupied property, the maximum deduction is Rs. 2,00,000 per annum, provided the loan is taken for acquisition or construction and the construction is completed within 5 years from the end of the financial year in which the loan is taken, otherwise, the deduction is restricted to Rs. 30,000.
In the case of property which is given on rent, there is no ceiling on the amount of interest deductible, though set-off of loss under the head house property, while it is restricted to Rs. 2,00,000 per year in case of other heads and the balance loss can be carried forward.
Readers also note that I will use chapter VI-A in article by which I mean that two sections of this chapter i.e. Section 80EE and 80EEA, whereas section 80EE allows an additional deduction of up to Rs. 50,000 per annum in respect of interest paid on a home loan taken by a first-time home buyer, subject to conditions relating to loan amount and value of the residential property. This deduction is over and above section 24(b) and is available for loans sanctioned within the specified period under the Act, while section 80EEA provides an additional deduction of up to Rs. 1,50,000 per annum for interest on home loans taken for affordable residential houses, subject to conditions such as stamp duty value limit and loan sanction dates. This deduction is also in addition to section 24(b) and is available only where section 80EE is not claimed.
Opinion of courts before amendment
There are many judicial decisions of high courts and ITATs which allowed interest paid on borrowed capital mainly the interest which was paid up-to the date of acquisition or during construction and directed that it is to be added to cost of acquisition or cost of improvement for capital gains computation.
Notable tribunal decisions in recent years allowed taxpayers to include unclaimed interest in cost of acquisition even where the interest had not been claimed earlier under section 24. The Kolkata ITAT in Bani Broto Banerjee v. CIT allowed inclusion of interest for the years prior to the amendment.
Citations: ITAT Kolkata (‘C’ Bench) order dated 18 November 2024 with ITA No.: 520/KOL/2023
However, where the AO finds that the interest claim had been treated elsewhere, or something else then he may disallow.
Now, before proviso, the taxpayers had an option to include certain interest amounts in cost of acquisition especially pre-construction interest and interest paid till acquisition/possession, but outcomes varied by facts and case to case.
Practical analysis
In case the interest not claimed earlier anywhere that means if you did not claim the interest as a deduction under section 24(b) or anywhere under chapter VI-A (section 80EE or 80EEA) in the previous assessment year(s) when the interest arose, several courts have permitted adding that unclaimed interest to cost of acquisition/improvement, particularly pre-construction interest or interest paid up to date of acquisition/possession.
Secondly, where interest on a home loan has already been claimed and allowed as a deduction under section 24(b) or under Chapter VI-A, the amended proviso to section 48 that is applicable from assessment Year 2024-25 onwards, prohibits adding such interest to the cost of acquisition or cost of improvement while computing capital gains, as this would result in a double tax benefit to the assessee. However, for assessment years prior to AY 2024-25, this restriction did not exist in the statute, and therefore taxpayers may still contest such disallowance based on facts and judicial precedents.
Now what is the pre-construction interest which is generally capitalised and the post-acquisition interest which is decreased from revenue?
Here the courts have recognised that pre-construction interest (interest during construction / before completion/possession) can be capitalised and treated as part of cost, but once interest has been claimed and allowed as an annual deduction under section 24, prospectively the benefit is barred from being added again to cost.
My Advice to the Client
First of all, I checked whether the interest had been claimed in any prior ITR under Section 24(b) or Chapter VI-A for the previous years. Though I didn’t find any such claim, in case it was found, then post-AY 2024–25 a statutory bar would apply. However, for pre-2024–25 years, litigation could be explored, though the risk profile differs from case to case.
Then I assessed the nature and period of interest, where pre-construction interest has a stronger case for capitalisation. Thereafter, I collected bank statements, loan account statements, interest certificates from the bank, construction invoices, payment vouchers, etc., to gather evidence, and completed documentation relating to stamp duty, registration charges, GST, etc.
In my case, the client hadn’t claimed any interest earlier. Accordingly, I prepared a detailed working showing the sale consideration, indexed cost of acquisition, interest amounts proposed to be capitalised, and indexed the same as well. To explain the legal basis of the savings to the client, I also prepared alternative computations with and without including interest.
Documentation
I advised the client to maintain certain documentation, such as the loan sanction letter and loan account statement showing the breakup of principal and interest, interest certificates from the lender, construction invoices, contractor receipts, possession certificate, builder receipts, stamp duty and registration receipts, copies of ITRs for the years where interest was claimed (to show whether deduction was claimed), etc.
Let’s Understand It with an Illustration
Suppose STS Ventures, which is a proprietorship consulting firm, purchases a property for Rs. 50,00,000. Pre-construction interest (not claimed under Section 24) is Rs. 3,00,000, and the sale price after 8 years is Rs. 80,00,000.
Now, the cost base without interest shall be Rs. 50,00,000, i.e., LTCG will be Rs. 80,00,000 minus Rs. 50,00,000, i.e., Rs. 30,00,000 (before indexation/exemptions). If interest of Rs. 3,00,000 is added to the cost, then the cost shall be Rs. 53,00,000 and the LTCG shall be Rs. 80,00,000 minus Rs. 53,00,000, i.e., Rs. 27,00,000, resulting in a reduction of taxable gain by Rs. 3,00,000. However, if interest was already claimed and allowed under Section 24, then post-AY 2024–25 the proviso prevents adding Rs. 3,00,000 again.
Thoughts
The amendment is aimed at preventing double benefit, i.e., claiming interest once under the head “House Property” and again as part of the cost of acquisition. The precise outcome in any case still depends on the timing of interest, whether it was claimed, and the assessment orders. Tribunal and High Court judgments remain relevant for years prior to the statutory change.
Conclusion
If you ask me whether the interest paid on a home loan can be added to the cost of acquisition of immovable property while selling it and calculating capital gains tax, I would affirm it. The reason is that, historically, tribunals and some High Courts have allowed interest paid on a loan used to acquire an immovable property to be included in the cost of acquisition (thereby reducing capital gains), unless that interest was already claimed and allowed as a deduction under Section 24 or Chapter VI-A. With effect from AY 2024–25, Parliament has inserted a proviso in Section 48 which expressly disallows inclusion of the amount of interest already claimed under clause (b) of Section 24 or Chapter VI-A in the cost of acquisition or improvement.
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Author can be contacted at aman.rajput@mail.ca.in
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