The other day, one of our friends declared his intention to put his flat out on rent. He himself lived in company provided accommodation in Mumbai but had purchased a flat in Pune for use during retirement. Since this flat was lying vacant, he had finally decided to let it out. When discussing this, it came to light that he was totally unaware of the myriad tax benefits available for renting property. After learning of the same, he regretted having waited so long before taking the decision to rent. This week, we share our discussion with our friend with readers.
Basically, tax is applicable where there is income and essentially there can be only two kinds of incomes related to property – rental income and of course capital gains when property is sold. In this article, we shall examine in detail the tax treatment of rental income.
The basis of calculating income from house property is the rental value. This is the inherent capacity of the property to earn income. Property income is perhaps the only income that is charged to tax on a notional basis. This charge is not because of the receipt of any income per se, but is on the inherent potential of the house property to generate income.
To put it differently, even if a taxpayer earns no income whatsoever from the second property, it will be taxable as if he has put it out on rent. Therefore, it would be advisable to actually rent the second property since anyway the owner will have to pay tax on an assumed rental value.
Note that this above discussion applies only in respect of house property; it does not cover a plot of land. Also, the first property is tax-free only if not let out. In other words, if you earn rent, whether from one property or more, all the rent is taxable. However, in cases where the property is not let out (or is self occupied) then one property is exempted from tax.
This was so far as tax on rental income was concerned. Now coming to tax deductions.
There are basically two types of tax deductions available on income from property apart from the actual municipal taxes paid. The first is standard deduction of 30%. This means 30% of the rental income can be reduced as a standard deduction for repairs, maintenance etc. irrespective of the actual amount spent, if at all, during the financial year.
The second deduction, which is over and above the 30% standard deduction is to do with interest on mortgage finance if of course, the property is purchased on mortgage.
In case the property is tax-free (on the lines mentioned above), the interest deduction is restricted to Rs. 150,000. In other words, irrespective of the amount of interest paid, if you do not pay any tax on the property, the deduction on account of the interest paid has a ceiling of Rs. 150,000.
However, for properties that are taxable on either actual rent or notional rent, the entire amount of interest paid without any limit is deductible. In fact, nowadays on account of currently ruling property prices, in almost all cases the interest amount far exceeds the rentals. Investors generally buy properties for the capital appreciation potential and in the meanwhile put the property on rent so that the asset does not remain idle and also gets maintained. However on account of market appreciation, rental yields have fallen to around 3-4% p.a.
In any case, coming to the earlier point, for rented properties the entire amount of interest payable can be adjusted against the rent and any amount that is left over may be adjusted against other income if any. Even after this if there is any balance left over, it can be carried forward in the tax return as loss from property to the next year.
This is very important from a tax planning point of view. Take for example our friend’s case. He is a salaried employee. Consequently, any left over interest after adjusting against rent can be further adjusted against salary income, thus bringing down the overall tax liability. For self-employed people who do not have salary income perhaps could set-off the interest against their capital gains. Or the unadjusted interest can be simply carried forward to next year. Such carry forward of the unabsorbed interest can be done for a continuous period of 8 years. Over the years, as the loan gets paid off, the interest component that is getting set-off against the rental income each year will keep reducing. On the other hand, typically the rent would tend to increase (increment) each year. This will go on to lead to a positive differential between the rent received and the interest paid and this difference would be taxable. At this point, the carried forward interest will be extremely useful to reduce tax
Extremely important planning tool this one. But remember, if you wish to carry forward loss, it is mandatory to file the tax return by the due date of 31st of July (for individual taxpayers). Without filing the tax return – and that too by the due date prescribed – carry forward of loss will not be allowed.
One last point regarding interest. Interest deduction can be claimed only when the possession of the property is taken. But often people buy under construction properties where the EMI or the mortgage payments begin during the construction phase itself. So what happens to the interest paid pre-possession?
Such interest is to be claimed as a tax deduction in five equal installments starting from the year in which the possession is obtained. A numerical example will help illustrate the point. Say someone has bought a property under construction in FY 09-10 and is paying an annual interest of Rs. 20 lakh. He gets the possession in current year 12-13. Therefore he has paid pre-possession interest for 09-10, and 10-11 of Rs. 40 lakh. One fifth of Rs. 40 lakh – that is Rs. 8 lakh can be claimed during 12-13 over and above the Rs. 20 lakh that he may pay in 12-13. Therefore, the deduction of interest for current year 12-13 would be Rs. 28 lakh (Rs 20 + Rs. 8 lakh). This is of course assuming the property is rented – else the deduction is restricted in toto to Rs. 1,50,000.
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