Should you buy an under-construction property? Pros and cons explained

Since the price difference between an under-construction property and a ready-to-move-in house is substantial, people are lured to go for an under-construction property without appreciating the implications of their decision. There are pros and cons involved with the decision either way. Since the benefits of going for a ready-to-move-in property outweigh its cons, I will explain why you should go for a ready-to-move-in house rather than taking the risk of booking an under-construction property.

I have divided this article into two parts for discussion purposes. In the first part, I will deal in general with various financial implications of a particular decision. In the second part, I shall explain the various income tax implications arising out of a particular decision.

Financial implications

Wise people have advice for all of us in the form of the saying, “one in hand is better than two in the bush”. This very aptly applies to the subject matter under discussion. The decision to go for an under-construction property has many risks associated with it, like, risk of default on the part of the builder in handing over the possession as promised.

You would have come across various frequent news reports about the delay in giving possession by the builders to the home buyers. The delivery of the property on time is an exception rather than a rule. The delay ranges from a few months to two or three years. The situation has improved with the introduction of RERA regulations, but the risk of delay in possession remains.

So, in case you decide to go for a ready-to-move-in house, you do not carry the risk of delay and default from the developer. You get immediate gratification for the money being paid by you. If you look at the activity around the redevelopment segment, you will find that every Tom, Dick, and Harry have become a builder without having adequate financial resources, which often is the cause of the delay.

Moreover, the delay in completing the construction cannot be attributable only to a lack of adequate financial resources, but also, in some cases, is linked to litigation related to the property title. So any delay for whatsoever reason adds to your agony and costs.

Most people exhaust their present savings for paying the booking amount, which comprises the full portion of black money. Home buyers also commit their future savings in the form of EMIs in a residential house, so it is not at all advisable to put their whole past and present savings at risk in this way.

Moreover, in case you are staying in a rented premise, your expenses on rentals continue while you are paying your EMI, thus causing a double whammy to you, when there is a delay on the part of the builder. There are many cases to my knowledge where the home buyer had to sell his under-construction house as it was not possible to fund both the payments, one for rentals and the other second EMI. And there ends the dream of owning a house.

In contrast, if you buy a ready-to-move-in flat, your rental payments stop. In case you shift to the new house immediately on taking possession, rentals stop, and EMI payments do not cause much burden on your finances. Even if you do not shift to the new house, you can always let that out and partly finance your EMI.

People fail to appreciate that booking an under-construction property is nothing but lending money to the developer at the higher rate of interest with accompanying risks of delay and default. With the grim situation of the real estate sector presently, where many of the projects are stopped due to the liquidity crunch of the developer, the prospects are very scary, with the probability of default of the developer going higher than earlier.

Taxation implications

In addition to the general financial implications discussed above, there are some income tax implications which go against the decision of going for an under-construction property. With skyrocketing prices of the property and the average age of the people buying their first property coming down significantly, it is not possible for an average middle-class family to own a residential house without a housing loan.

For housing loans taken for an under-construction property, the pre-EMI interest starts even before the completion of the property. In some of the cases where possession is delayed, even the payment of EMI starts before possession.

As per the prevalent income tax provisions, you can claim the income tax benefits for a home loan taken for a residential house only after the construction of the property is complete and you have taken possession. It may also be noted that in respect of the interest paid during the construction period, you can claim the same in five equal installments beginning from the year in which possession of the property is taken by you.

In case of self-occupied house property, the maximum amount of deduction available for interest under Section 24(b) is restricted to Rs. 2 lacs under the old tax regime, and no benefit is available under the new tax regime. So, in case the interest for the current period itself exceeds or is equal to Rs. 2 lacs, you effectively lose your claim in respect of pre-EMI interest.

In case you have to sell the under-construction property before taking possession, you altogether lose your tax benefit in respect of interest paid by you during this period. Moreover, in case you sell your house before completing five years after taking possession, you lose the claim on your respective installments of pre-EMI interest.

There is another implication with respect home loan taken for self self-occupied property if the possession of the property is abnormally delayed. It may be noted that the benefit of Rs. 2 lacs in respect of interest under Section 24(b) on self-occupied house property is available only if the construction is completed within a period of five years from the end of the financial year in which the housing loan was taken.

So, in case the construction of your house is not completed within five years as stipulated, your eligibility drastically comes down to Rs. 30,000, in case the same is used for your own residence.

However, there is no upper limit for interest deduction in case the house property is let out, subject to there being a limit of Rs. 2 lakhs up to which you can set off the losses under the house property head against other income under the old tax regime. Under the new tax regime, you can claim interest only up to the amount of taxable rent. So, in addition to the risk of delay and default for an under-construction property, you also carry the risk of lower tax benefits in case the developer delays the possession beyond five years.

For repayment of a home loan, you get a deduction of up to Rs. One lakh fifty thousand, along with other eligible items under the old tax regime. This benefit is also available only after you have taken possession of the property. So, in case you have repaid part of the home loan during the construction period, you lose the tax benefit for such repayment forever, as there is no legal provision for amortization of the benefits, unlike the interest paid during the construction period.

Section 54 and 54F allow you an exemption from capital gains tax arising from the sale of any asset held for more than 24 months if you buy a house within two years before or after one year of such transfer. You are also entitled to a similar exemption in case you construct a residential house within three years. So, in case the developer fails to complete the construction and hand over the possession in the stipulated time period, you again carry the risk of having to pay capital gains tax, which you had planned to save.

Finally, going for a ready-to-move-in house will give you more peace of mind than going for an under-construction property. The decision to go for an under project will always have a hanging sword on your head of delay or default by the developer.

The above discussion is of no relevance for the people who do not have enough money to pay for a ready-to-move-in house and have to invariably go for an under-construction house. So take your own call after evaluating all the pros and cons of both options as per your situation and depending on your present financial resources.

Balwant Jain is a tax and investment expert and can be reached at jainbalwant@gmail.com and @jainbalwant his X handle.