Taxation on house property need not be complicated. Taxes are applicable only if the property generates income through rent or by way of the capital gains at the time of selling the property.
Tax on rental income
The basis of calculating income from house property is the rent earned from it. This is the inherent capacity of the property to earn an 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 property to generate income.
So to begin with, the first property that one buys is exempt from income tax. However, there is a notional rent value attached to the second property. This is based on the market-based rental value.
So, even if a taxpayer earns no income whatsoever from the second property, then too, it will be deemed let out and taxed as if put on rent. Therefore, it would be advisable to actually rent the second property.
This applies only to housing property and not plots of land. Also, the first property is tax-free only if not let out. In other words, if you earn a 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.
Tax deductions
There are basically two types of tax deductions available on income from property apart from the actual municipal taxes paid. Under the standard deduction, 30 per cent of rental income can be reduced as a deduction for repairs and maintenance, irrespective, of the actual amount spent, during the financial year.
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The second deduction is to do with interest on mortgage finance. The interest deduction is restricted to Rs 1.5 lakh for tax-free property. In other words, irrespective of the 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 1.5 lakh.
However, for properties that are taxable on either actual rent or notional rent, the entire interest paid without any limit is deductible. High property prices mean, the interest far exceeds the rental income. 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 three to four per cent per annum.
For rented properties, the interest payable can be adjusted against the rental income and any amount that is left over may be carried forward in the tax returns as loss from property to the next year. From tax planning point of view, you can carry forward losses from property for eight continuous years.
Over the years, as the loan gets paid-off, the interest component that is getting adjusted against the rental income each year will keep reducing. On the other hand, typically, the rent would tend to increase due to increments 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 interest carried forward will be extremely useful to reduce tax liability. But, if taxpayers do not file returns by July 31, carry forward of loss will not be allowed.
Interest deduction can be claimed only when the possession of the property is taken. But often people buy under construction properties where the equated monthly instalments (EMIs) or the mortgage payments begin during the construction phase itself.
Such interest paid pre-possession is to be claimed as a tax deduction in five equal installments starting from the year in which the possession is obtained. Say someone has bought a property under construction in financial year 2008-09 and is paying an annual interest of Rs 20 lakh. He gets the possession in current year, 2010-11. Therefore, he has paid pre-possession interest for 2008-09, and 2009-10 of Rs 40 lakh. One fifth of Rs 40 lakh, that is, Rs 8 lakh can be claimed during 2010-11 over and above the Rs 20 lakh that he may pay in 2010-11. Therefore, the deduction of interest for the year 2010-11 would be Rs 28 lakh. This is of course assuming the property is rented – else the deduction is restricted to Rs 1.50 lakh.
The writer is Director, Wonderland Consultants