In this day and age of tax consultants and e-tax filing, one seldom examines the details in the tax return. Income earned from your house property is one such detail, and which forms a key component of your tax return. While those having a single self-occupied property need not bother, owners of multiple properties face a tax liability, as an unoccupied house attracts income as well as taxes, even if it lies vacant. Thus, it makes better sense to let out your properties on rent to avail twin benefits: a steady rental income and huge savings on your tax outgo.
Own multiple houses? Keep one, let out the other
Investing in a residential property to leverage ups and downs of the real estate market is quite distinct from generating a steady income. While the former gives rise to capital gains and related tax liabilities, the “income” that your house earns is billed differently. Self-occupied properties (SOPs) only serve as dwelling units for the owners and do not earn any income. However, on purchase of a second house, you derive certain income and herein comes the taxman calling. However, there are exceptions:
• If you own a house in Mumbai, but are unable to occupy it as you work and reside in another city, then both houses are treated as self-occupied and, thus, not considered eligible for income generation.
• In case you buy two adjacent flats under a single agreement and combine them so as to have, say, a common entrance and kitchen, it may be treated as a single SOP. In all other cases, the second house is deemed to be let out, even if it is kept vacant, and a notional rate is charged based on the potential annual rental income from the property. Why then shoulder the expenses of an empty house and also pay tax, when letting it out on lease could significantly reduce the tax bill? Here’s how you can save on taxes on the properties you own.
In your interest
A sharply lower tax bill is one of the prime benefits of renting out that “extra” flat. Given the typically huge interest outgo on a home loan, renting out that house will allow you to claim the entire interest paid to the bank in a year, as a deduction. This compares to a mere `1.5 lakh interest deduction that a self-occupied property will offer (the amount will be `2 lakh from assessment year 2015-16).
This strategy could also benefit those who have purchased one property, but do not plan to move in any time soon. A let out house thus ensures a steady source of income. However, the tax savings on the interest outgo could taper as the loan tenor progresses. The magnitude of the tax saving will be higher in the initial years. It will also depend upon factors such as the home loan amount that you have borrowed, tenor and interest rate. Even in a base case scenario, if you have borrowed, say, an amount of `30 lakh at 10.1%, for 30 years, you will have an interest outgo of `3-3.5 lakh in the first decade, which could set off your tax liability significantly.
Even if you have rented out your only house property, and are staying on rent yourself, the taxman allows you to claim house rent allowance (HRA). Thus, instead of occupying the house on which you are paying off a home loan, you could claim a double benefit by letting it out: one, by earning rental income, and claiming a full deduction on the home loan interest paid to the bank; and two, by saving your tax outgo further through the HRA route.
How to handle unrealized rent
Often, the annual interest outgo more than offsets any rental income that is received over the year, thereby lowering tax liability. However, even with rental income, you have to bear in mind a possibility of “unrealized rent”. Deducting the unrealized rent portion will lower your house property income in a given year if you claim a deduction year. However, unrealized rent, if realized in a subsequent year, will attract full tax and the standard deduction of 30% allowed in other cases, will not be applicable, as you have already claimed a deduction once.
In addition to benefits of letting out your ready-to-move-in house property on rent, you can also claim tax deductions on home loan interest paid during the under-construction phase, after you get possession.