Exemption on interest

In case of a home loan taken for a self occupied property, the principal amount repaid up to 1 lakh qualifies for deduction under Section 80C, while up to 1.5 lakh of interest paid is tax-deductible under Section 24. However, in case of a home loan for the second property, only interest payment is eligible for deduction. But the good part is that there is no limit on the deduction for interest payment on the second loan (see Benefit of buying a second house). This is because the second house has been given out on rent.

If the house is yet to be constructed, 20% of the total interest paid during the pre-construction period is also allowed as tax deduction. This is available for five years from the time the construction is complete till you get possession.

Deductions allowed on income from second home

Even if the second house is lying vacant, the IT Department will consider that it has a rental value. The notional or deemed income will be added to your taxable income. A buyer can deduct expenses, such as municipal or property taxes actually paid, from the deemed income. Other than this, 30% of the net annual value, which is the difference between the rental income and municipal taxes, is also allowed as deduction.  

After deducting such expenses from the income that you earn from the property, if you incur a loss, you have the option to set it off as follows:

The current year's loss will first be set off against other income from property. It can also be set off against other incomes, such as that from salary, business etc, earned in the current year.

If your balance continues to be in the red, you can carry forward the loss for up to eight years. However, the amount that is carried forward is only allowed to be set off against the income that is earned from a house.

How to save on taxes

If you own several houses, you can choose one as your primary residence. The income from this property will be treated as nil and exempt from tax, even if you have actually rented it out. It is for this house that the limit of 1.5 lakh applies for deduction on loan interest. The entire interest on the loan taken for the other house, the income from which is taxable, can be deducted from your income. So, to maximise your savings, consider the house with the highest loan as the non-exempt one. However, make sure that the interest payment on this loan is higher than the principal-cum-interest payment on the other loan.

If any of the houses is sold after three years, the profit will be taxable as long term capital gains. But if you invest the money to construct a house within three years or buy another house within two years, your income will be tax-exempt. However, the exemption is reversed and the amount taxed as capital gain if the new property is sold within three years of being constructed/purchased. This will be considered a short-term gain and taxed according to your slab rates.

You can also save tax if you invest the profit in a special bank account under the capital gain account scheme. A similar exemption is available for investments of up to 50 lakh in bonds, which are redeemable after three years. This investment should be made within six months of the sale.