Buying a sea-facing apartment with modern amenities is something many of us aspire in our economic life cycle. Thanks to home loans and double income families, dreams that until a decade ago appeared farfetched, now seem achievable.

Apart from buying a house to live in – a primary home – today real estate is looked upon as an asset class to invest in. Rise in property prices over the last few years has encouraged many to evince faith in real estate as an investment avenue. So if you were to ask for your family, friends, and colleagues for a promising investment avenue, many would suggest investing in property.

But recognising the tax angle is equally important before you go ahead and invest your own funds and / or take/acquire a loan. This will holistically help you make a wise investment decision coherent with your tax planning. In this edition of FNS, we’ll take you through the implications of investing in house property.

First, let’s understand what is meant by “House Property”.

According to the Income Tax Act, 1961 a house property consists of any building or land appurtenant thereto of which the assessee is the owner. The appurtenant land may be in the form of a courtyard or compound forming part of the building. But such land is to be distinguished from an open plot of land, which is not charged under this head but under the head “Income from Other sources” or “Business Income”, as the case may be.

Besides, house property includes flats, shops, office space, factory sheds, agricultural land, and farm houses. Further, house property includes all type of properties viz. residential, godowns, cinema building, workshop building, hotel building, etc.

Here are the essential conditions for taxing income under “Income from House Property”…

Income from house property is taxable in the hands of its legal owner in whose name the property stands. The “Owner” for this purpose means a person who can exercise the rights of the owner, not on behalf of the owner, but as in his/her own right. A person entitled to receive income from a property in his/her own right is to be treated as its owner, even if no registered document is executed in his name.

The following three conditions must be satisfied before the income of the property can be taxed under the head “Income from House Property”:
 

• The property must consist of buildings and lands appurtenant thereto;
• The assesse must be the owner of such house property;
• The property may be used for any purpose, but it should not be used by the owner for the purpose of any business or profession carried on by him, the profit of which is chargeable to tax.

If the property is used for own business or profession, it shall not be chargeable to tax.

Classification of house property:

The Income Tax Act, 1961 classifies a house property as:

• Self-occupied Property (SOP) i.e. the house you actually live in
• Let out property (LOP) i.e. the house which you’ve leased out
• Deemed to be let out property (DLOP) i.e. the term used in case you own more than one house property, where one will be treated as self-occupied while the other(s), would automatically be classified as a “deemed” to be let out.

Proforma of computation of Income from House Property

Particulars	House I (SOP)	House II (LOP)	House III (DLOP)
Gross Annual Value (GAV)	NIL	XXX	XXX
Less: Municipal taxes paid by the owner during the year	NIL	(XX)	(XX)
Net Annual Value (NAV)	NIL	XXX	XXX
Less: Deductions u/s 24:
a) Standard Deduction @30% of NAV	NIL	(XX)	(XX)
b) Interest on borrowed capital	(XX)	(XX)	(XX)
Income from house property	(XX)	XXX	XXX

Gross Annual Value (GAV):

A ‘self-occupied property (SOP)’, will derive no Gross Annual Value throughout the financial year. Since the Gross Annual Value is Nil, the municipal tax paid by the owners too is not allowed to be deducted. Hence the Net Annual Value (NAV) of such a property is Nil. However, if a home loan’s taken to buy this property, the interest component in the EMI is eligible for deduction under Section 24 (b), subject to a maximum limit of Rs 200,000. But if the loan is taken for the purpose of repair, renewal, or reconstruction of the SOP, the eligible deduction is restricted to Rs 30,000. Hence the income derived from a SOP will always be in the negative which can help in the tax planning exercise.

For ‘let-out property (LOP)’ or a ‘Deemed to be Let Out Property (DLOP)’ Gross Annual Value is calculated using the following steps:

Step 1: Computation of Reasonable Expected Rent (RER):

RER would be higher of the following:

• Municipal value of the property; or
• Fair rent of the property

Note:If a property is covered under Rent Control Act, then the RER cannot exceed the standard rent.

An illustration here will help us understand the GAV of LOP and DLOP better:

Particulars	Property A (Rs)	Property B (Rs)	Property C (Rs)
Municipal Value (MV)	850,000	850,000	850,000
Fair Rent (FR)	250,000	250,000	250,000
Standard Rent (SR)	900,000	150,000	Not Applicable

The reasonable expected rent is the higher of municipal value or fair rent subject to a ceiling of standard rent. Based on the above discussion, the computation of reasonable expected rent would look as follows:

 

Calculation of Reasonable Expected Rent (RER)
Property A	MV: Rs 850,000 FR: Rs 250,000	Higher 850,000	SR: Rs 900,000	RER: Rs 850,000
Property B	MV: Rs 850,000 FR: Rs 250,000	Higher 850,000	SR: Rs 150,000	RER: Rs 150,000
Property C	MV: Rs 850,000	Higher 850,000	SR:Not Applicable	RER: Rs 850,000

Step 2: Compute actual rent of the property

Actual rent means the rent for which the property is let out during the year. While computing actual rent, rent pertaining to vacancy period is not to be deducted. However, unrealised rent* is to be deducted from actual rent if conditions specified in this regard are satisfied.

In the case where the property (or any part of the property) is let out but was vacant during the whole or any part of the previous year, and owing to such a vacancy, the actual rent received or receivable by the owner in respect thereof is less than the reasonable expected rent, then the actual rent so received or receivable (as reduced by the vacant allowance) shall be considered to be the Gross Annual Value of the property.

*Unrealised rent is the rent of the property which the owner of the property could not recover from the tenant, i.e. rent not paid by the tenant. If the following conditions are satisfied, then the unrealised rent is to be deducted from actual rent of the year:

• The tenancy is bona fide;
• The defaulting tenant has vacated the property, or steps have been taken to compel him to vacate the property;
• The defaulting tenant is not in occupation of any other property of the taxpayer;
• The taxpayer has taken all steps to recover such amount, including legal proceedings or he satisfies the Assessing Officer that legal proceedings would be useless

Step 3: Higher of step 1 or 2 will be the gross annual value in case of a let out property

 

Sr. No	Particulars	Amount	Amount
a	Reasonable expected rent		XXX
b	Actual rent:
	Actual rent received (rent per month x let out period)	XXX
	Less: Unrealised rent (if any)	XXX
	Net actual rent		XXX
c	If the property is vacant for any period then:
	Total rent received (as if there was no vacancy and without deducting the unrealized rent) (rent per month x 12 months)		XXX
	Gross Annual Value (GAV)		XXX
Note: Compare a with c; if a is greater than c, then a is the GAV, else b

Let’s take an illustration to understand the concept of computing the GAV better:

 

Particulars	House I (Rs)	House II (Rs)	House III (Rs)
Municipal Value (MV)	120,000	170,000	200,000
Fair Rent (FR)	160,000	200,000	240,000
Standard Rent (SR)	180,000	220,000	Not Applicable
Actual Rent (per month)	12,000	18,000	21,000
Period of Vacancy	NIL	1 month	6 month
Unrealised Rent	12,000	NIL	21,000

Step 1: Computation of reasonable expected rent (RER):

 

Particulars	House I (Rs)	House II (Rs)	House III (Rs)
Municipal Value (MV) (a)	120,000	170,000	200,000
Fair Rent (FR)(b)	160,000	200,000	240,000
Higher of MV or FR (c)	160,000	200,000	240,000
Standard Rent (SR) (d)	180,000	220,000	Not Applicable
Reasonable Expected Rent (e)	160,000	200,000	240,000
Unrealised Rent	12,000	NIL	21,000

Note: If a property is covered under Rent Control Act, then the reasonable expected rent cannot exceed the standard rent

Step 2: Computation of actual rent of the property

 

Particulars	House I (Rs)	House II (Rs)	House III (Rs)
Actual rent (per month) (a)	12,000	18,000	21,000
Period of vacancy (b)	NIL	1 month	6 month
Period occupied (c) = (12 - b)	12 months	11 months	6 months
Rent received (d) = (a x c)	144,000	198,000	126,000
Unrealised rent (e)	12,000	NIL	21,000
Net rent received (f) = (d - e)	132,000	198,000	105,000
Actual rent (as if there was no vacancy) (without subtracting the unrealized rent) (g) = (a x 12 months)	144,000	216,000	252,000

Step 3: Computation of gross annual value (GAV)

 

Particulars	House I (Rs)	House II (Rs)	House III (Rs)
Reasonable expected rent (as calculated in step 1) (a)	160,000	200,000	240,000
Actual rent (as if there was no vacancy) (without subtracting the unrealized rent) (as calculated in step 2 - g) (b)	144,000	216,000	252,000
Higher of a and b	(a)	(b)	(b)
Net rent received (as calculated in 2 – f) (c)	NA	198,000	105,000
Gross annual value (GAV)*	160,000	198,000	105,000
Note*: If the property is let out and vacant for part of the year and the net rent received is less on account of vacancy then the net rent received will be the GAV

After having computed Gross Annual Value for LOPs and DLOPs in a manner elucidated above, any municipal taxes towards these properties would be subtracted to obtain the Net Annual Value (NAV).

Remember, over here in case you have multiple DLOPs, then you have an option to consider one of property as a SOP and the rest would be considered as DLOPs under the present Income Tax law. So, say you have four such DLOPs then you could select the property with the highest GAV as a SOP property but weigh the pros and cons undertaking a comparative analysis to optimize your tax planning exercise.

Deductions under Section 24:

• Standard deduction: Owning a home and maintaining the same, costs money. Hence the Income Tax Act 1961 provides you with a flat deduction of 30% of the Net Annual Value irrespective of the amount expended, which here is called as the standard deduction. This deduction is of specific use for LOP and / or DLOP properties.


• Interest on borrowed capital: Where the property has been acquired, constructed, repaired, renewed or reconstructed with a loan, the amount of any interest payable on such capital is allowed as a deduction. The quantum of deduction depends upon the purpose for which you take a loan – i.e. purchase, construction, reconstruction, repair or renewals, and also the type of property – i.e. SOP, LOP or DLOP. Loan taken for the purpose of purchase or acquisition of the house which is an SOP, is eligible for maximum deduction a sum of Rs 2,00,000. But if the loan is taken for the purpose of repair, renewal, or reconstruction, then the eligible deduction is restricted to Rs 30,000. On the other hand, if the property is LOP or DLOP, then you do not have any maximum restriction to claim interest–so it can be above the otherwise limit of Rs 2,00,000, irrespective of the usage – i.e. whether for the purpose of purchase, construction, reconstruction, repair or renewals.
   

Take an illustration to understand how calculate income from house property better:

 

Particulars	House I – LOP (Rs)	House II – DLOP (Rs)	House III – SOP (Rs)
Municipal Value (MV)	120,000	170,000	200,000
Fair Rent (FR)	160,000	200,000	240,000
Standard Rent (SR)	180,000	220,000	Not Applicable
Actual Rent (per month)	12,000	18,000	21,000
Period of Vacancy	NIL	1 month	6 month
Unrealised Rent	12,000	NIL	21,000
Municipal taxes for the year	20% of Municipal value	40,000	50,000
Municipal tax paid during the year	24,000	NIL	30,000
Interest on borrowed capital	100,000	150,000	200,000

Computation of income from house property:

Particulars	House I (Rs)	House II (Rs)	House III (Rs)
Gross Annual Value (GAV) (a)	160,000	198,000	NIL
Less: Municipal taxes paid by the owner during the year (b)	24,000	NIL	NIL
Net Annual Value (NAV) (c) = (a-b)	136,000	198,000	NIL
Less: Standard Deduction @ 30% (e)	40,800	35,400	NIL
Less: Interest on borrowed capital (f)	100,000	150,000	150,000*
Income from house property (g) = (c-e-f)	- 4,800	12,600	-150,000

Conclusion:

Owning real estate/ property has its merits and demerits. You see, buying real estate/ property can have big impact on your other long term financial goals. So weigh all aspects, including tax implications when you plan to own a house property. If you prudently approach investing in a house property, you may carry out effective tax planning. >

PersonalFN believes that if you are buying a house for dwelling, anytime might be a good time to buy (assuming you have assessed the affordability). But if you want to buy a house from investment point of view, then taking a holistic view of your portfolio would be better. At PersonalFN, we believe your investments should be in congruence to the financial goals you have in mind.

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jugnu@gmail.com Nov 27, 2018 fff

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