Can home loan interest reduce your capital gains tax in the new tax regime? Explained

If you are paying home loan interest for a self-occupied property and filing taxes under the new tax regime, you cannot claim a deduction for the interest paid to the bank. The interest deduction is available only for taxpayers under the old tax regime, as per Section 24B.

As you cannot claim a deduction in the new regime, you might be tempted to add the interest amount to your cost of acquisition to reduce your capital gains while selling this self-occupied property. But, is it allowed? Or, can you do it legally?

We consulted with CA Dr. Suresh Surana to find the correct answer to the above query. The following is an edited version of his response and suggestion for taxpayers:

What's the rule?

Interest payable on borrowed capital used for acquiring, constructing, renewing or reconstructing a house property is ordinarily allowable as a deduction under section 24(b) while computing income under the head “Income from house property.”

What can be added to the cost of acquisition?

Historically, disputes arose where taxpayers sought to claim a double benefit by first claiming a deduction of such interest under section 24(b) during the holding period of the property and, thereafter, capitalising the same interest as part of the cost of acquisition or cost of improvement under section 48 while computing capital gains on sale.

In order to address this issue, the Finance Act, 2023 amended section 48 to expressly provide that the “cost of acquisition” or “cost of improvement” of a capital asset shall not include any interest which has been claimed as a deduction under section 24(b) or under Chapter VI-A of the IT Act.

As clarified in the Memorandum to the Finance Bill, 2023, the legislative intent behind this amendment was to prevent taxpayers from claiming a double deduction in respect of the same interest expenditure. However, the amended provision does not explicitly prohibit capitalisation of interest in cases where no deduction has been claimed under section 24(b) owing to opting for the concessional tax regime.

Differing views

One view can be that since the taxpayer has not availed any deduction for such interest, allowing the same to be included in the cost of acquisition at the time of sale would not result in a double benefit and, therefore, would not violate the object of the amendment introduced by the Finance Act, 2023.

On the other hand, the tax authorities may contend that permitting capitalisation of home loan interest under section 48, when such deduction is otherwise not available under the new tax regime, may not align with the intent of the concessional regime and consequently, the revenue may argue that even indirect recognition of such interest through capital gains computation defeats the purpose of section 115BAC.

Even the judicial authorities have taken different views on whether interest can be included as part of the cost of acquisition.

The Delhi ITAT, in Rajesh Saluja v. DCIT (order dated 15 February 2024), held that the cost of acquisition should include only expenditure having a direct nexus with the purchase of the property and that interest on borrowed funds does not have such a direct nexus, and therefore cannot be included in the cost of acquisition.

In contrast, the Jodhpur ITAT in Gayatri Maheshwari v. ITO (order dated 5 May 2017) held that where a property is acquired out of borrowed funds, the interest paid on such borrowing is intrinsically connected with the acquisition and forms part of the cost of acquisition for capital gains purposes.

What should taxpayers do?

In the context of the amendment to section 48, it would be prudent to adopt a conservative approach by not capitalising unclaimed housing loan interest as part of the cost of acquisition, as such a position may be susceptible to disallowance and could result in unintended tax and penalty exposure, as well as prolonged litigation with the tax authorities.