Want to renovate home? Top-up loan offers tax deduction on interest portion

Tax benefit is available only if the funds are used for repair and renovation

During the festive season, many borrowers opt for a top-up on their existing home loan if they are planning for a big expenditure like renovating their home or constructing an additional room. Unlike a home loan, which fetches a borrower income-tax (I-T) deduction on the principal as well as the interest, the tax benefits in case of a top-up loan vary with end-use.

When an individual is looking to raise a large sum, a top-up is the cheapest loan he can get against an asset with minimum paperwork. Private lenders such as Axis Bank offer the loan at 8.45-12.10 per cent and HDFC at 8.50-9.20 per cent, according to the data from Paisabazaar.com. 

Public sector banks like Union Bank of India have interest rates ranging between 9.60 per cent and 9.85 per cent, while UCO Bank offers it at 9.95 per cent.

Lenders don’t have a restriction on the end-use of the loan. They take an undertaking from the borrower for taking a top-up. Many individuals, therefore, take a top-up for home renovation, home extension, child’s education or marriage, or even when they are consolidating their existing loans. In the case of businesspersons, a top-up loan can be used to meet the cash flow requirement. As the end-use differs, so does the tax benefit available.

The basic principle of tax benefit is similar to a regular home loan. “An individual can get tax deduction for payment of interest on the top-up loan used for purchase, construction, repair or renovation of the house property. The deduction under Section 80C (principal portion) is allowed when a property is purchased or constructed,” says Neha Malhotra, executive director, Nangia Advisors.

If you are constructing a new house or purchasing a ready property with a top-up, you can get a tax deduction on the principal as well as the interest portion. The same holds true if you are constructing an additional room. If you are buying an under-construction property, the regular home loan rules apply. The principal portion gets a deduction up to a maximum of Rs 150,000. 

“The borrower can claim the interest portion of the equated monthly instalment (EMI) paid during the pre-construction period – that is, the period from the date of borrowing of loan till date of completion of construction – as a deduction in five EMIs, beginning from the year of completion of construction,” says Preeti Khurana, a chartered accountant with ClearTax. But the claim of deduction of such pre-construction interest, along with the regular interest, should not exceed Rs 200,000 during any given financial year.

The deduction would also depend on whether the top-up is taken for a self-occupied house. For a self-occupied property, the maximum interest deduction one can claim under Section 24 is Rs 200,000 in a financial year. “If the house has been given on rent, the entire interest paid on the home loan can be claimed as deduction under Section 24. The overall loss the taxpayer can claim under the head ‘house property’ is restricted to Rs 200,000 only. Any loss from house property that remains after set-off during the year can be carried forward for set-off against house property income,” says Khurana.

But if the loan is taken for home renovation, tax experts say only the interest paid on such a loan is restricted to a maximum of Rs 30,000 in a financial year. If the top-up loan is taken for any other purpose such as education of children, their marriage or for business purpose, no I-T deduction is available. The business owner can, however, claim the interest portion as an expense, which will go to reduce a taxpayer’s taxable profit.

A lender may open a separate account for a top-up loan. “Maintaining the same or a separate loan account would not have a bearing on the tax treatment of a top-up home loan,” says Malhotra.