The other day, when talking about tax saving, someone asked me if the interest payable on a home loan is directly deductible from the salary income.

When I said no, all the others were up in arms quoting Section 24 of the Income Tax Act.

While I am not disputing the section, contrary to popular perception, the interest payable on a home loan is not directly deductible from their salary or business income.

What actually happens is that a calculation of income from house property is made and, if the calculation results in a loss, it is allowed to be set off against your income.

Confused? Don't be.

Read on to figure this out.

Let's say you take a home loan to buy or construct a home.

Let's also assume that is your first home.

If it is your second home, the tax calculation differs and we shall tackle that in a later article. Here, we will only look at the situation if you have taken a home loan to buy or construct your first home.

The heads under which income tax is calculated

• Income from salary
• Income from house property
• Profits and gains of business/ profession
• Capital gains
• Income from other sources

How is income from house property calculated?

How it works

Self-occupied property
When you take a loan to buy a property to live in, the tax man calls it a self-occupied property. 

Rent = 0
In this case, rental income is treated as 'Nil'. Not a great favour really because you anyway don't derive any rental income from such property as you stay there. 

Therefore, when you calculate the income from this property, it will always result in a loss. How much is the loss? It is equivalent to the interest you pay on the home loan. Got it? The tax man views the home loan interest payment as negative income from house property.

Hence:
A = 0
S = 0 (30% of zero is zero).

Thus, the only deduction available is the interest payable on the home loan taken to buy the property.

Section 24

In such cases, where 'A' is allowed to be taken as nil, the deduction for interest is restricted by the tax man to a maximum of Rs 1,50,000 per annum.

Thus, in such cases, the Income from House property will always result in a loss equivalent to the interest payable on the home loan or Rs 1,50,000, whichever is lower.

This loss under the head 'Income from house property' is allowed to be set off against your salary/ business income. 

Section 80C

The principal repaid is allowed as a separate deduction under Section 80C, subject to the overall limit of Rs 1,00,000.

Under Section 80C, investments as well as certain other payments are considered.

For example, Investments in provident fund, Public Provident Fund, infrastructure bonds, National Savings Certificate, life insurance premiums, pension plans and Equity Linked Saving Schemes of mutual funds all qualify under Section 80C.

So do payments towards the principal amount of your home loan and education fees for children.

Let's say:

Salary income: Rs 3,20,000

Home loan interest payment: Rs 1,20,000

Home loan principal repayment: Rs 80,000

NSC investment: Rs 30,000