Rental income is taxed under the Income tax act under the head “Income from House Property”.
A. Rental Income
Rent actually received during the year.
Note: Rental income is taxable whether there is a signed lease agreement or not. However, we recommend always signing a lease agreement to avoid any hassles in the future.
B. Fair Market Value of Rent
While the prescribed approach involves calculation of Municipal Value,Fair Rent and Standard Rent and then deriving the fair market value of rent, such an approach generally isn’t practically possible.
In such a case, the generally accepted method is to determine the Market rent going on in the area/ vicinity of the subject property.
Note: We recommend our clients to preserve any conversations with brokers/ market participants, newspaper articles, etc. indicating the fair market value of rent in the locality. Such backup is extremely useful in case of an inquiry/ scrutiny by the Income Tax Department.
C. Higher of A or B
For the purpose of our example, we assumed that Rental income received is higher than Fair Market Value of Rent. However, in case Fair Market Value of Rent is higher than Rental Income received, the assessee must pay tax on the higher Fair Market Value (even if such rent is not actually received by them).
This is an anti-avoidance provision that is essentially aimed at curbing the practice of signing leases at a value lower than the Fair Market Value, and the settling the balance amount in cash.
However, in our experience, this leads to the certain practical difficulties such as:
Often an assessee leases out property to a relative at rentals lower than market. Such assessee is required to burden of tax on fair market value of rent, even if rent received is minimal.
In a falling Real Estate market, often Fair Market Value of Rent has fallen significantly. However, the same may be difficult to justify to the Income Tax Department as leases signed in the past may be at a significantly higher value.
Note: In the case of leased property which is vacant for part of the year, if the actual rent received is less than the Fair Market Value of Rent for the whole year owing to vacancy, then rent actually received is considered (even if Fair Market Value of Rent is higher).
This is an important provision that allows an assessee to reduce his tax liability in case of a slowing Real Estate market. See Practical considerations below.
D. Municipal Taxes Paid
It is important to note that Municipal taxes actually paid during the year are deductible. However, if municipal taxes have accrued but not been paid, then no deduction is available.
Note: We have often observed that individuals, particularly NRIs, often pay municipal taxes in advance to avoid the monthly hassle. In such case, deduction is available in the year in which payment is made.
E. Net Annual Value
F. 30% Deduction
The Income Tax Act allows a flat deduction of 30% on any rental income received. This deduction is irrespective of any expenditure incurred by the assessee.
Note: Clients often ask us if they can claim a deduction for maintenance work, commission, brokerage, etc. paid by them. However, there is no provision for claiming such deduction. The 30% flat deduction was presumably provided by the Income Tax Act to account for such expenditure.
G. Interest on Borrowed Capital
Interest payable on loans borrowed for the purpose of acquisition, construction, repairs, renewal or reconstruction can be claimed as a deduction.
Interest on a fresh loan taken to repay the original loan raised earlier is also an admissible deduction.
Quite often, an assessee takes a loan to pay for a property that is still under construction. The Income Tax Act has a peculiar way of granting such deduction. Let us illustrate with the help of an example.
Pre-construction interest can be claimed as deduction over a period of 5 years, in equal installments, commencing from the year of acquisition or completion of construction.
Interest relating to the year of completion of construction can be fully claimed in that year irrespective of date of completion (i.e. even if construction is completed on 31 March 2020, deduction is available in FY 2019-20)
Self occupied property:
In case the assessee has taken a loan for a property (self occupied), the same provisions as described above apply. However, the maximum amount of deduction is capped at INR 2 lakhs.
These provisions lead to some interesting practical situations such as what happens if the property is let out for part of the 5 years and then self-occupied for the remaining period. There is definitely some scope for planning your taxes here.
What must also be noted is that let out property in this case also includes deemed let out property (explained in detail below).
H. Taxable Income
Finally, we arrive at the Taxable Income of the assessee. Tax is payable on such income at applicable rates. These rates differ for individuals, partnerships and companies.
Certain practical issues faced by clients that we have dealt with in the past include:
What happens if the property is let out for part of the year and self occupied for the remaining part.
Considering the poor performance of the real estate sector, properties are lying vacant with no tenants available. Can vacancy be claimed for the full year?
What happens in case of disputes where the tenant does not pay rent but does not vacate the property either?
An assessee may purchase or sell the property during the year. However, the provisions only talk about annual value. Should the rent considered be pro-rated based on ownership?
Clients have often asked us if they can claim that their commercial property is self occupied for the purpose of residence. In such a case, the tax liability would decrease since commercial rentals are usually higher than residential rentals.
Points to Remember:
In case of a house property, a portion of which is let out and a portion self-occupied, income from any portion which is let out shall be computed separately under the “let out property” category and the other portion or part which is self-occupied shall be computed under the “self-occupied property” category.
In case of property situated outside India, taxes levied by local authority of the country in which the property is situated is deductible.
For the purpose of claiming deduction of INR 2,00,000 against interest on loan borrowed, the assessee should furnish a certificate from the lender, specifying the amount of interest payable by the assessee.
In case the property is co-owned, income from house property shall be split between the co-owners on the basis of ownership stake. All deductions are available to all co-owners.
It is important to be mindful of clubbing provisions in case of transfer of property to spouse/ minor child.
Be mindful of the GST implications on rental income.
To read about TDS to be deducted on rent paid, click here.
Frequently asked questions
An assessee receives composite rental income for the property, furniture and fixtures, and other services such as lift, security, etc. How will this income be taxed?
If let out property and other assets are inseparable:
Where composite rent is received from letting out of building and other assets (like furniture) and the two lettings are not separable i.e. the other party does not accept letting out of buildings without other assets, then the rent is taxable either as business income or income from other sources, the case may be.
This is applicable even if sum receivable for the two lettings is fixed separately.
If let out property and other assets are separable:
Where composite rent is received from letting out of buildings and other assets and the two lettings are separable i.e. letting out of one is acceptable to the other party without letting out of the other, then
- income from letting out of building is taxable under “Income from house property”
- Income from letting out of other assets is taxable under the head “Profits and gains from business or profession” or “Income from other sources”, as the case may be.
This is applicable even if a composite rent is received by the assessee from his tenant for the two lettings.
An assessee earns rental income from a property located outside India. Is such income taxable in India?
In case of a resident in India (resident and ordinarily resident in case of individuals and HUF), income from property situated outside India is taxable, whether such income is brought into India or not.
In case of a non-resident or resident but not ordinarily resident in India, income from a property situated outside India is taxable only if it is received in India.
For more information on Residential Status, click here.
For more information on what income is taxable in India, click here.
What is a deemed let out property?
Where the assessee owns more than two properties for self-occupation, then the income from any two such properties, at the option of the assessee, shall be computed under the self-occupied property category and their annual value will be nil.
The other self-occupied/ unoccupied properties shall be treated as “deemed let out properties”.
All provisions relating to a leased property apply mutatis mutandis to the deemed let out property.
Note: The option can be changed year after year in a manner beneficial to the assessee.
The tenant defaulted on payment of rent. Do I still have to pay tax on income I have not received?
Actual rent received should not include any amount of rent which is not capable of being realised.
However, certain conditions are to be fulfilled for claiming such deduction. These are:
- the tenancy is bona fide
- the defaulting tenant has vacated, 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 assessee
- the assessee has taken all reasonable steps to institute legal proceedings for the recovery of the unpaid rent or satisfies the Assessing Officer that legal proceedings would be useless.