There has been a furious debate on the household's penchant for investing in physical assets such as real estate and the methods by which such a skew can be corrected. The ability to use unaccounted money to pay for such a purchase, as well as the consumer-unfriendly nature and poor returns from the more popular financial assets, have been the main drivers behind the continued popularity of real estate. A lesser-known driver is the subsidy the Government of India provides for purchase of real estate.
Let me explain. Real estate is popular among many professionals, as well as the business class, as a store of black money, which can help launder the unaccounted income at the time of exit. It helps that the white money part of the transaction can be easily financed by way of loan. It helps further that in respect of investment properties (given out on rent), the entire interest is deductible for tax purposes without any limit, unlike the upper limit of Rs 2 lakh for a self-occupied house. The rental income is around two per cent of the market value, of which only 70 per cent is taxable because of standard deduction (meaning only 1.4 per cent is taxable) and the interest is around 10 per cent, resulting in a loss of 8.6 per cent of the property cost every year.
This loss is allowed to be set off against the salary/business/other income of the investor, making this a very powerful incentive for both high earning corporate professionals, businessmen and self-employed professionals. This is a perverse incentive, considering the deduction for the house is limited to Rs 2 lakh if used for own residence. This unlimited set-off allowed during the same year has been in the statute books since the 1960s when home loans were unheard, Hence, it was not really material at that time. Today, when most purchases are financed with home loans, it is leading to a significant loss of revenue, beside unintendedly incentivising investment in real estate. The government can stop this incentive by providing that the loss on account of rented-out real estate can be set off only against profit from other rented out real estate properties and any leftover loss can only be carried forward and set off against real estate income in the future years.
I don't have data but this should significantly boost tax revenues for the government. If the suggestion is accepted, the government needs to ensure the set-off allowed for loss on account of self-occupied property is not affected. In the spirit of transparency, the government should also make it clear the amendment applies only for losses on account of properties purchased after the Income Tax Act is amended, and the old position of allowing losses to be set off in the same year should be allowed to continue for properties bought prior to the amendment.
Another subsidy the government is giving but does not seem to be aware of is in respect of interest payable on under-construction properties. According to existing law, interest payable on a loan taken to buy a property that is still under construction at the end of the financial year cannot be claimed as a deduction. However, this stipulation is widely ignored (either deliberately or from ignorance of law) and most buyers go ahead and claim this deduction anyway, despite the property being under construction. They get away with it in the absence of any way to verify the status of the property. A simple amendment in the I-T forms, as well as the declaration employees are required to give to their human resources department should make tax payers/employees self-certify the year in which the property was first available for actual use. Those who wish to follow the law (fortunately, a majority) will stop claiming this deduction incorrectly. Some tax payers might still go ahead and give an incorrect declaration but if their returns are scrutinised, at least they won't be able to feign ignorance of the law and the fear of penal consequences would deter most payers. About 60 per cent of all home loans are given in respect of under-construction property and even this simple change (which requires only a notification from the Central Board of Direct Taxes) should have a significant impact on this unintended subsidy given for real estate property.
Mr Finance Minister, are you listening ?
The writer is director, Apnapaisa.com
