When you take a loan with the purpose of seeking financial assistance, usually to buy an asset, the loan principal along with the interest is paid back in EMIs. EMI stands for equated monthly instalments, and has to be repaid within a specified number of months. For instance, if you have taken a home loan you will be making a monthly repayment to the bank. The total amount to be repaid is calculated inclusive of the interest and principal components.
The final amount to be repaid every month is calculated in a way that it stays static over the entire repayment period. EMI only starts once the loan is disbursed by the bank/ financial institution. There are multiple factors governing the amount of EMI to be paid. These are the principal loan amount, loan tenure, mode of calculation of interest, and interest rate. If the loan tenure.
With a longer loan tenure, the EMI amount goes lower; with a shorter loan tenure, the EMI amount becomes higher as you have substantially lesser time to repay your loan. In case of longer loan tenures, the principal component is less and the interest component is more during initial stages. This starts working in reverse, over the years, and the principal component becomes more while the interest component gets lesser. The reason behind this is simple. During the initial years, the outstanding loan amount is higher, but with the years the outstanding amount becomes lesser.
What is a Pre-EMI
On availing a home loan, Pre-EMI is relevant when the building's construction is yet to be completed. For an apartment under construction, the builder’s payment is somewhat dependent on the stages of construction. The amount of time required for the completion of the building construction depends on the speed with which the builder works, which further depends on various factors.
Owing to these reasons, the complete sum for the apartment/building is not disbursed to the builder. The disbursement is made partially, and is linked to the various stages of construction. As mentioned earlier, the loan repayment (EMI) starts only after the full loan amount has been given to the builder. Despite this arrangement, the builder needs to pay EMIs even during the partial loan disbursements – these EMIs are known as Pre-EMIS. Please note, that the interest component (to be paid on pre-EMIs) is the amount of interest accrued on the amount disbursed until then.
Taxes During Pre-EMIs
Only after the construction of the building (for which the loan has been availed) has been completed can a tax deduction on the pre-EMIs (for the preconstruction period) can be availed. On completion of the construction, the total pre-EMI interest paid, in the subsequent years, is deductible in 5 equal instalments.
For instance, on a Pre-EMI of Rs.5 lakhs, Rs 1 lakh will be depicted as tax deduction for the next 5 years. Pre-EMI is only the interest paid during the period. Please note that any principal amount is not eligible for tax deduction. The interest payable for the year of completion of construction, (inclusive of interest payable for the years during which the construction anticipated to be completed) is deductible under Section 24. All the interest payable, with reference to the periods until the year of construction, needs to be aggregated. This is allowed as a deduction in 5 EMIs. This starts from the year of completion of the construction.
Sometimes capital repayments on the loan are made during the years of the building being under construction. In this case, no tax deductions are applicable on this. If the capital repayment is made after the completion of the property construction, then it is eligible for deduction, with an upper limit of Rs 1 lakh per annum.
Pre-EMI tax benefit case study
In order to understand the implications of tax benefits on Pre-EMIs paid towards a loan, check out the example mentioned below.
Kritika has taken a loan worth Rs.20 lakh in order to begin the construction of a residential property located at Kanpur in October 2015. While she has been paying a monthly installment of Rs.18,000 since the time the loan was disbursed, the project was completed in November 2017 and has been rented out from December 2017.
Since homeowners can claim interest deductions on the loan taken for the construction while filing for an income tax return only after the project is completed, Kritika is eligible for tax benefits only from the financial year 2017-18.
Here is a detailed account of her EMI payments:
- Kritika has paid a total amount of Rs.18,000 X 12 = Rs.2,16,000 during FY 2016-17 towards her EMI. Additionally, she has paid Rs.14,000 was towards the repayment of the principal amount.
- Hence, the total amount of interest towards the loan is Rs.2,16,000 + Rs. 14,000 = Rs.2,02,000.
- Since the concerned property has been on rent, Kritika is eligible to claim a tax deduction of the entire amount paid as interest based on Section 80C of the Income Tax Act, 1961.
- However, in order to claim the repayment of the principal amount worth Rs.14,000, the property should not be sold within the next 5 years.
- The amount claimed by Kritika under Section 80C will be added to her total income of the year in which the property is sold. If the property is sold before the completion of 5 years, she will be taxed according to her total income of the year.
The time period between the first disbursal of the loan and the end of the financial year immediately prior to the year of completion of the construction project is generally known as the pre-construction period. The deduction of interest for the pre-construction period is allowed for the interest repayments that have been made between the end of the financial year before the date of completion of the project and the date of borrowing.
The details of the interest paid while the property was under construction is mentioned below:
In the previous scenario, the pre-construction EMI payment is applicable for 21 months from October 2015 till November 2017. Therefore, the breakup is:
| Time period | Interest paid |
|---|---|
| October 2015 to March 2016 (FY 2015-16) | Rs.18,000 X 6 = Rs.1,08,000 |
| April 2016 to March 2017 (FY 2016-17) | Rs.18,000 X 12 = Rs.2,16,000 |
| The total interest paid is Rs.3,24,000 | |
The amount for principal repayment was included in the total amount for EMI payment. Therefore,
Total interest paid - Principal repayment amount = Pre-construction interest
Rs.3,24,000 - Rs.24,000 = Rs.3,00,000
This amount can be claimed by Kritika in 5 equal installments amounting to Rs.60,000 from the financial year 2017-18.
Hence, the total amount that Kritika will be able to claim as deduction towards the interest paid for the loan during the FY 2017-18 is:
Rs.2,02,000 + Rs.60,000 = Rs.2,62,000
Tax benefits under the Income Tax Act, 1961
Check out the tax benefits that you will be able to avail for the payment of interest under Section 24 and Section 80C of the Income Tax Act, 1961.
Deduction amount permitted under Section 24 for interest payment
| Completion Status | Self-Occupied Property | Not Self-Occupied Property |
|---|---|---|
| Completed in 3 years | Rs.1,50,000 | No limit |
| Completed in more than 3 years | Rs.30,000 | No limit |
Difference between tax benefits that can be availed under Section 80C and Section 24
| Particulars | Section 80C | Section 24 |
|---|---|---|
| Tax deduction applicable for | Principal | Interest |
| Tax deduction basis | Paid | Accrual |
| Total amount of tax deduction applicable | Rs.1.5 lakh | In case of self-occupied property: Rs. 2,00,000 In case of non- self occupied property: No limit |
| Loan offered for | Purchase or construction of a new house property | Construction, reconstruction, repair, renewal or purchase of a residential property |
| Tax deduction eligibility criteria | Nil | Construction or purchase has to be completed within 3 years |
| Restriction on the sale of property | Tax deductions claimed are subject to be reversed if property is sold within 5 years | Nil |
