Under-construction house cancellation can help buyer get tax benefit

After three years of booking, it is considered as a long-term capital asset

When a buyer cancels a property in an under-construction project for tax purposes, the transaction is considered similar to selling a house. And, the tax treatment can benefit the buyer if he gives up the property after three years.

In a recent case, a Mumbai-based lawyer bought three flats in a project, for which he paid Rs 50 lakh as advance. The construction was delayed owing to regulatory hold-ups, due to which the buyer decided to surrender the flats. Apart from the booking amount, the developer paid the buyer an additional Rs 1.1 crore as compensation.

As the buyer had cancelled the booking after three years, he offered the compensation as long-term capital gains under Section 45. The assessing officer denied it and treated the settlement money as the taxpayer’s income under the head “income from other sources”. But when the taxpayer appealed against the order, the tax tribunal upheld his plea. “There have been high court judgments that when a person books a residential property, he acquires the right to it. The right is considered a capital asset. In this case, the tribunal therefore ruled in favour of the taxpayer,” said Kuldip Kumar, partner & leader, personal tax, PwC India.

Capital assets held for over three years qualify for long-term capital gains. A taxpayer gets indexation benefits, which can lower the tax outgo. This also means that if a developer refunds only the booking amount, without any interest or compensation, there would be a long-term capital loss if indexation is considered, which can be used to set off long-term capital gains in the future. If the property is cancelled within three years, and the developer offers compensation along with the booking amount, the latter will be clubbed with the taxpayer’s income and taxed in accordance with his income-tax slab.

If the buyer had taken a home loan for buying the house, he would not get any income tax benefit on it. According to the income tax provisions, for an under-construction property, a borrower gets the tax benefit once the house is completed. On completion, a borrower can claim deduction on the interest paid during the construction phase in five equal instalments. “If the house is sold before the completion, he has to forego the deductions as he is giving up the rights to a house that was not completed,” says Naveen Wadhwa, a chartered accountant with Taxmann.com.

While the buyer may not get the tax deduction, he can claim the interest paid on loan as an expense to buy the house. “Interest incurred, brokerage paid, etc, in such a case would be an expense, which can be deducted when calculating tax outgo,” says Kumar.
 

Also, if a buyer has received compensation from a developer and used the money to buy or construct a house, he can also get tax deduction under Section 54F. In this section, if the taxpayer sells a long-term capital asset and uses the proceeds to buy or construct a house, he can save the tax outgo.

Saving tax on compensation

• Cancelling an under-construction house is similar to selling it
• Compensation from a developer can be offered as long-term capital gains
• The tax outgo on compensation is lower due to indexation benefit
• The taxpayer can also save tax under Section 54F by buying or constructing a new house