It may not be a good investment given the current tax laws.
Saving tax is a pet preoccupation with our citizenry. Sometimes, it borders on the ridiculous. While saving taxes is a legitimate exercise, one needs to evaluate if it makes sense to make certain investments only to save tax.
Investments, by definition, need to give a reasonable return after taxes. But, one cannot invest without considering the tenure, liquidity, risk potential, returns, suitability and so on for meeting goal. Tax efficiency is just one aspect of it.
Due to the rapid rise in the property value in the past five years, many have assumed that it will continue it’s upward rise, uninterrupted. It may or may not happen. However, it will not rise at a compounded 20 per cent, like it has in the past. It’s most likely to settle at a sedate single digit long-term growth rate of maybe 7-8 per cent. Massive increases in property prices have stalled the markets and transactions have come down.
Property is bought for residential use and as an investment. If it is for use as one’s home, then tax considerations recede into the background, as the buyer will use it for personal consumption. Let us examine the tax concessions for a self-occupied property.
For such a property (where the whole or part is not let out and no benefit is derived from it), the maximum interest permissible to be set off would be Rs 1.5 lakh. This is subject to the condition that the capital is borrowed on or after April 1, 1999. The deduction is Rs 30,000 a year for capital borrowed towards acquiring home property before April 1, 1999. Also, the acquisition/construction should be completed within three years from the end of the financial year in which capital was borrowed. The lender needs to certify in respect of the interest payable against the loan taken.
So, in case a person is taking a loan of Rs 50 lakh and the interest in the first year comes to Rs 5 lakh, he could avail a deduction of only Rs 1.5 lakh. The tax saved is Rs 46,350, assuming the borrower is in the highest tax slab. Hence, if tax saving is the pre-eminent consideration, it is going to be met only to a small extent. In this situation, an EMI in the region of Rs 50,000 per month would also be added and has to be carried on for years or two decades!
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Again, people have the view that it is still a good idea, as an asset gets created. Many have the view that when one starts paying an EMI, the surplus cash will be used up and the chances of frittering away any surpluses comes down. While this is true, it also creates a long-term liability. This creates a problem in case of any income disruption. Especially in a situation when the loan taken requires two people to work, which is mostly the case today. If the husband and wife are working, and they have a small child at home, both of them have to continue working even if the lady wants to stay back to take care of the child.
Also, people are very mobile and their careers can take them to various cities or even abroad, over time. If they have invested in one city, say Mumbai, and they get transferred to, say, Delhi, they will have to put the house in Mumbai on rent and rent another in Delhi. This beats the very purpose of buying a home.
Also, the argument that in future, homes will become be unaffordable is also untenable. As it is, even today the prices in many suburban areas are unaffordable for most middle class households. Assuming a long-term increase of seven to eight per cent in property, it can clearly be bought at a later point when one has dropped the anchor. Till such time, it may be a good idea to stay in rented properties, which are available at reasonable prices. Typically, the annual rental is about three to four per cent of the value of the property. This gives one the flexibility and freedom to pursue opportunities unhindered.
In sum, buying a residential property for residential purposes makes sense if,
- A person is clear that this is the city to settle;
- Property price is fair
- Buyer are prepared to shoulder the responsibility of repaying the loans for an extended period of time.
The writer is a certified financial planner