Loan from Relatives for Home Purchase: Can You Claim Interest Deduction?

When it comes to income tax deductions, many taxpayers are not aware that they may be able to claim a deduction for interest paid on loans taken from relatives. This can be a valuable tax-saving opportunity, especially for individuals who have borrowed funds from family members to purchase a home, fund a business, or for other personal expenses. However, to claim the deduction, there are certain conditions and documentation requirements that must be met. Let us explore whether you can claim income tax deduction on interest paid to relatives, the eligibility criteria, and the latest updates regarding home loan interest deductions for FY 2025-26.

---

Table of Contents

• Can You Claim Income Tax Deduction on Interest Paid to Relatives?

• Eligibility Criteria for Interest Deduction on Loans from Relatives

• Documentation Requirements for Claiming the Deductions

• What If the Loan is Interest-Free or Not Documented?

• Latest Updates for FY 2025-26 on Home Loan Interest Deductions

• How to Maximise Your Interest Deduction on Relatives’ Loans

• Conclusion

• FAQs

---

Can You Claim Income Tax Deduction on Interest Paid to Relatives?

Yes, you can claim an income tax deduction on interest paid to relatives, but there are certain conditions attached.Section 24(b) of the Income Tax Act allows taxpayers to claim a deduction on interest paid on loans for purchasing or constructing a house property. This deduction is available whether the loan is taken from a financial institution or a relative. However, it is crucial that the loan is legitimate, properly documented, and that the interest paid is supported by evidence, such as a loan agreement or proof of payment.

For instance, if you take a loan from a relative to buy a house, you can claim a deduction under Section 24(b) on the interest paid on that loan, provided the necessary criteria are met. However, if the loan is informal or undocumented, claiming this deduction becomes complicated, and the tax authorities may not accept it.

Eligibility Criteria for Interest Deduction on Loans from Relatives

To qualify for the income tax deduction on interest paid to relatives, the loan must meet specific eligibility criteria:

• Genuine Loan Agreement: The loan must be a genuine loan and not a gift. The interest rate charged should be reasonable and consistent with prevailing market rates. This ensures that the loan agreement is recognized by the tax authorities.
  

• Purpose of Loan: The loan should be used for a purpose eligible for tax deductions, such as the purchase or construction of a house property. If the loan is used for other purposes, the interest paid may not qualify for a tax deduction.
  

• Proper Documentation: There must be a formal loan agreement that clearly outlines the terms, including the interest rate, repayment schedule, and the total amount borrowed. Both the lender (your relative) and the borrower (you) must sign this agreement.
  

• Interest Payment: Payments must be made to the relative as per the agreement. A record of all payments, such as bank transfers, should be maintained. Cash payments are not ideal for this purpose as they can lead to disputes or non-acceptance of deductions.

Documentation Requirements for Claiming the Deduction

To claim the deduction on interest paid to relatives, proper documentation is crucial. The following documents are typically required:

• Loan Agreement: A formal written agreement between you and the relative stating the terms of the loan, such as the amount, interest rate, and repayment schedule. This agreement should be signed by both parties to ensure it is legally binding.
  

• Interest Payment Proof: Bank statements or payment receipts showing the transfer of interest payments to the relative. These are essential for proving that the loan payments were made and that the interest deduction is justified.
  

• PAN Details: Both the borrower and the lender should provide their Permanent Account Numbers (PAN) to ensure transparency and traceability of the transaction.
  

• Tax Filings: Whenfiling your ITR, you must report the interest paid under the section that allows deductions for housing loans. Properly reporting the interest payment and providing the documentation to support your claim will help you avoid complications during assessment.

What If the Loan is Interest-Free or Not Documented?

If the loan is interest-free or not documented, claiming an income tax deduction on the interest becomes problematic. For a loan to qualify for the tax deduction, it must be a genuine loan, and there must be a clear, documented agreement that specifies the terms, including the interest rate. If the loan is interest-free, the tax authorities will likely not allow the deduction, as there is no interest being paid.

Similarly, if the loan is not documented, it could be considered a gift rather than a loan, and no tax deduction would be allowed. The tax authorities may also question the legitimacy of the loan if there is no written agreement or proper record of the transaction. To ensure you can claim the deduction, it is essential to have proper documentation and a formal agreement that specifies the loan details.

Latest Updates for FY 2025-26 on Home Loan Interest Deductions

For FY 2025-26, the government has made several key changes to tax benefits related to home loans, including loans taken from relatives. These updates may impact the way you claim deductions on home loan interest:

• Increased Deduction Limits: The deduction limit for interest paid on home loans has been raised, providing taxpayers with more opportunities to save on taxes. The new limits apply to both interest paid on loans from financial institutions and from relatives.
  

• Extended Eligibility for First-Time Homebuyers: First-time homebuyers may qualify for additional deductions under certain conditions. This includes deductions on the principal repaid underSection 80Cand the interest paid under Section 24(b).
  

• Interest Rate Transparency: There are now clearer guidelines regarding the interest rates charged on loans taken from relatives. The rates must align with the prevailing market rates to be considered legitimate for tax purposes.

These updates help make the process of claiming deductions more straightforward and can provide significant savings for homebuyers, particularly when loans are taken from family members.

How to Maximize Your Interest Deduction on Relatives’ Loans

To maximize your interest deduction on loans from relatives, consider the following tips:

• Charge a Reasonable Interest Rate: Ensure that the interest rate on the loan from your relative is comparable to current market rates. This will make the loan appear legitimate in the eyes of the tax authorities.
  

• Maintain Proper Documentation: Keep all records of the loan agreement, interest payments, and any related correspondence. This will provide strong evidence in case of any scrutiny from tax authorities.
  

• Use the Loan for Eligible Purposes: Ensure that the loan is used for eligible purposes, such as purchasing or constructing a home, which qualifies for tax deductions under Section 24(b).
  

• Repay as Per Agreement: Adhere to the agreed-upon repayment schedule and ensure that all payments are made through traceable means, such as bank transfers, to avoid complications.

By following these steps, you can ensure that you maximize the deductions available to you and avoid any issues during the tax filing process.

Conclusion

Claiming income tax deductions on interest paid to relatives can be a valuable way to reduce your tax liability, especially if the loan was used to purchase or construct a home. However, it’s crucial to meet all the eligibility requirements and maintain proper documentation. The latest updates for FY 2025-26 have made it easier to claim home loan interest deductions, but it’s essential to ensure that the loan agreement is formal, the interest rate is reasonable, and the payments are well-documented. By following the necessary steps and ensuring compliance, you can take full advantage of the tax benefits available.

For a smoother, more efficient tax filing experience, it is highly recommended to download theTaxBuddy mobile appfor a simplified, secure, and hassle-free process.

FAQs

Q1: Can I claim an income tax deduction on interest paid to a relative for a loan used to buy a house?

Yes, you can claim a deduction on the interest paid to a relative for a loan used to buy a house under Section 24(b) of the Income Tax Act. However, the loan must be used exclusively for the purpose of purchasing, constructing, or renovating a house property. The interest paid on such a loan will be eligible for deduction, provided the loan is documented with a formal agreement and the interest rate is reasonable, not exceeding the market rate.

Q2: Do I need a formal agreement to claim a deduction on interest paid to a relative?

Yes, a formal written agreement is essential to claim a tax deduction on interest paid to a relative. The agreement should clearly outline the loan's terms, such as the interest rate, repayment schedule, and the loan amount. This ensures that the transaction is legally valid and can be considered as a genuine loan, not a gift.

Q3: What if the loan from my relative is interest-free?

If the loan from your relative is interest-free, you cannot claim any tax deduction for the interest, as no interest is being paid. The tax authorities may treat the loan as a gift, which does not qualify for any deductions under the Income Tax Act. However, you may still be liable for tax implications if the loan amount exceeds the prescribed limits under gift tax regulations.

Q4: Can I claim deductions on the interest paid to a relative if the loan is used for purposes other than buying a house?

No, the deduction for interest paid on a loan under Section 24(b) is only available if the loan is used to purchase, construct, or renovate a residential property. If the loan is used for any other purpose, such as for business or personal expenses, the interest paid will not qualify for deductions under this section.

Q5: What documents do I need to claim a deduction on interest paid to a relative?

To claim a deduction on interest paid to a relative, you will need the following documents:

• A signed loan agreement detailing the terms of the loan (interest rate, repayment schedule, etc.)

• Proof of the interest payments, such as bank statements or payment receipts

• PAN details of both the borrower and lender

• Any supporting documents, such as property ownership or construction proof, if the loan is used for buying or constructing a property

Q6: Can I claim deductions if the loan from my relative is not documented?

No, if the loan from your relative is not documented, you will not be able to claim a deduction for the interest paid. Without a formal loan agreement, the loan will likely be considered a gift, and gifts do not qualify for tax deductions. Therefore, it’s crucial to have a written agreement with clear terms.

Q7: How can I maximize my interest deduction on a loan from a relative?

To maximize your deduction on interest paid to a relative, ensure the loan is used for an eligible purpose, such as buying or constructing a house. Maintain a reasonable interest rate, similar to current market rates, and ensure that the loan agreement is clear and well-documented. Proper documentation and adherence to the rules are key to avoiding issues with the tax authorities.

Q8: What are the tax benefits for first-time homebuyers in FY 2025-26?

First-time homebuyers can benefit from tax deductions under Section 80C for principal repayment and Section 24(b) for interest paid on the home loan. In addition, first-time homebuyers may also qualify for an additional deduction of up to ₹50,000 underSection 80EE for interest on loans up to ₹35 lakhs, subject to conditions like the value of the property not exceeding ₹50 lakhs.

Q9: Can I claim the deduction for a loan from a relative if it’s used to buy a second home?

Yes, you can claim the deduction for interest paid on a loan used to buy a second home, as long as the loan is used for the purpose of purchasing or constructing the property. The same deduction under Section 24(b) applies regardless of whether the home is the first or second property, as long as it qualifies under the specified conditions.

Q10: What interest rate should I charge my relative for the loan to be considered legitimate?

The interest rate charged on the loan from a relative should be reasonable and in line with prevailing market rates. Charging a rate that is significantly higher or lower than market rates could raise concerns with the tax authorities, leading to scrutiny or potential disallowance of the deduction. It is advisable to charge an interest rate that reflects the rate offered by financial institutions or banks for similar loan products.

Q11: Are there any penalties for errors in claiming interest deductions on a loan from a relative?

Yes, if you fail to meet the requirements for claiming the deduction, such as not having a formal agreement or documentation, the tax authorities may disallow the deduction. Additionally, if the information is found to be inaccurate or if there is an attempt to claim false deductions, penalties and interest charges may apply. It’s important to maintain all required documentation and ensure compliance with tax laws to avoid penalties.

Q12: Does TaxBuddy help with claiming deductions on interest paid to relatives?

Yes,TaxBuddy can assist you in claiming deductions on interest paid to relatives by ensuring that you meet all the necessary requirements. TaxBuddy’s platform helps verify that all documentation is in place, including the loan agreement and proof of interest payments, and ensures compliance with the latest tax regulations. Whether you’re filing independently or using expert assistance, TaxBuddy simplifies the process and helps you maximize your eligible deductions.