Mukesh Patel.in
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TAX CONCESSIONS FOR RENTAL INCOME

Standard deduction & interest on borrowed capital help effectively scale down your tax rate on rent

Under the provisions of the Income-tax Act, the annual value (AV) of a house property let-out on rent is determined on the basis of the following:

  • The fair rental value of the property, not exceeding the standard rent determined or determinable under the relevant Rent Control Act.

  • Actual rent received or receivable, if such amount is higher than the fair rental value.

  • Where the property has remained vacant for whole or part of the year and owing to such vacancy, the rent received or receivable is less than the fair rental value, such lesser amount.

From the gross annual value as computed above, municipal taxes (including service taxes such as education cess, water taxes, etc.) levied by any local authority in respect of the house property are required to be deducted if these are borne by the owner. The amount left after deduction of municipal taxes is known as the net annual value. From the net annual value as determined above, the relevant deductions as available under Section 24 (discussed hereinafter) are to be deducted.

DEDUCTIONS FROM HOUSE PROPERTY INCOME

As per Section 24, the following two deductions are to be allowed from the net annual value for the purposes of computing the taxable income under the head ‘income from house property.’

  • Standard Deduction: A composite standard deduction of 30% of the net annual value. This deduction effectively replaces the earlier deductions for repairs and collection charges, insurance premium, annual charge, ground rent, and land revenue, which were separately available until Assessment Year 2000-01.

  • Interest on Borrowed Capital: Interest payable on borrowed capital is allowed as a deduction, if the capital is borrowed for the purpose of purchase, construction, repair, renewal, or reconstruction of the house property. In case of a let-out property, there is no monetary ceiling for this deduction.

The interest payable by a taxpayer in respect of funds borrowed for the acquisition or construction of a house property and pertaining to the period prior to the previous year in which such property has been acquired or constructed, is allowed as a deduction in five equal annual installments, commencing from the previous year in which such house is acquired or constructed. It must also be borne in mind that as per CBDT’s Circular No.28, dated 20th August, 1969, the interest on a fresh loan, taken to repay the original loan raised for the above purpose, is also allowable as deduction. However, interest on unpaid interest is not deductible.

TAX CONCESSIONS FOR RENTAL INCOME

    Investment in house properties, whether residential or commercial can be an attractive proposal both for deriving reasonable rental income and planning to effect valuable tax savings. Keeping in view the benefit of the above-referred two deductions, a taxpayer can enjoy quite significant tax savings while computing his tax liability on rental income, as will be evident from the practical case studies given below:

Case Study-1: Mr. P purchases a residential flat for Rs.60,00,000 from his own capital and gives it out on monthly rent of Rs.50,000.  The municipal taxes are to be borne by the tenant.  In this case, the annual value of the let-out property will be Rs.6,00,000.  However, considering the standard deduction of Rs.1,80,000 (at 30% of the AV), the taxable income from property will be Rs.4,20,000 (6,00,000 – 1,80,000).

If Mr. P is in the maximum tax bracket of 30.9%, the income-tax on the taxable rent would be Rs.1,29,780.  Considering the benefit of standard deduction, the effective rate of tax would work out to 21.63%, much lower than his applicable tax rate of 30.9%.

Case Study-2: Mr. R constructs commercial premises for Rs.75,00,000 using Rs.45,00,000 out of his own funds and borrowing Rs.30,00,000 at 12% per annum.  He lets out the property at an annual rent of Rs.9,00,000.  The annual property taxes of Rs.1,50,000 are borne by Mr. R.

In this case, the AV will be determined at Rs.7,50,000 after deducting the property taxes from the rent received. Considering the standard deduction of Rs.2,25,000 (at 30% of 7,50,000) and interest payable on borrowed capital of Rs.3,60,000 (at 12% of 30,00,000), the net taxable income will be Rs.1,65,000 and if Mr. R is in the tax bracket of 30.9%, the income-tax thereon will work out to Rs.50,985.

Keeping in view both the deductions enjoyed, the income-tax of Rs.50,985 on the liquid income of Rs.3,90,000 (after deducting interest of Rs.3,60,000 and property taxes of Rs.1,50,000 from the rent of Rs.9,00,000), effectively works out to just around 5.67% of the rent and 13.07%% of the liquid income.

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