This year’s Union Budget brought a few positives in form of lower tax slab rate for tax slab Rs 2.5 lacs-Rs 5 lacs and reduction in holding period for long term capital gains for real estate from 3 years to 2 years.
But there was a major shock for real estate investors. Set off of Loss under Income from House Property against any other income head (salary etc) has been capped at Rs 2 lacs (Amendment to Section 71 of the Income Tax Act). This is likely to disappoint many. Many investors invest in real estate not just for capital appreciation or rental income but also for tax benefits. Till now, there was no such cap (at least for let out property). Let’s see how this cap affects your income tax liability.
How Income from House Property Is Calculated?
Net Annual Value = Annual Rental Income – Municipal Taxes
Income From House Property = Net Annual Value – Standard Deduction (@30% of Net Annual Value) – Interest on Borrowed Capital (Home loan)
For a self-occupied property, the Net Annual Value is NIL (Section 23 of the Income Tax Act). You can try out this calculator on Income Tax website. Income From House Property is one of the sub-sections of the calculator. Recommend you go through this tutorial on Income Tax website to see how annual rental income is calculated in various scenarios.
Consider an example where you have rented out a second house for Rs 30,000 per month. That makes it an annual rent of Rs 3.6 lacs. Reduce it by standard deduction of 30% and by municipal taxes of say Rs 10,000 per annum. Your annual income is down to Rs 2.45 lacs. This income would be taxed at your marginal income tax rate. However, if you have taken a home loan for the property, you can reduce the interest paid towards such a loan from the income. If the interest paid is higher than the rental income (after standard deduction and taxes), it results in a loss (under Income from House Property). Till now, you could set off the entire resulting loss against income from salary or business. So, if you paid interest of Rs 6 lacs in a financial year for a let-out property, your loss under income from house property would be Rs 3.55 lacs (Rs 6 lacs – Rs 2.45 lacs). Effectively, this could have help reduce your taxable income by Rs 3.58 lacs. This would have resulted in tax-saving of Rs 1.09 lacs if you were in 30% tax bracket. You would save Rs 73,130 and Rs 36,565 if you were in 20% and 10% tax brackets respectively.
With this budget proposal, set off of loss under Income from House property (Rs 3.55 lacs in above example) will be capped at Rs 2 lacs per annum.
- This cap of Rs 2 lacs is for Loss under Income from House Property (and not for interest paid for let-out property)
- You can carry forward the loss for next 8 years but it is not likely to bring much relief.
- There is no impact on tax benefits on home loan repayment for a self-occupied property. You get tax benefit for interest payment for up to Rs 2 lacs per financial year under Section 24 of the Income Tax Act. And it remains that way.
- However, do note for interest on a home loan for self-occupied property will eat into the cap of Rs 2 lacs. For instance, if you paid interest of Rs 2.2 lacs for a self-occupied property in a financial year, the loss under Income from House property is already Rs 2.2 lacs. There is nothing left to avail for any other property.
- Earlier, these two were separate. Continuing with the above example, you could have claim total benefit of Rs 4.58 lacs. Rs 2 lacs (out of Rs 2.2 lacs) for self occupied property and Rs 2.58 lacs for the let-out (or deemed to be let out property).
Illustration
| Income Tax Calculation | Till March 31, 2017 | From April 1, 2017 | Till March 31, 2017 | From April 1, 2017 |
| Taxable income before adjustment for Income from House Property (X) | 20,00,000 | 20,00,000 | 20,00,000 | 20,00,000 |
| Income from Self Occupied Property | ||||
| Interest paid on loan for self-occupied property | 220,000 | 220,000 | – | – |
| Income from Self Occupied Property (A) | (200,000) | (200,000) | – | – |
| Income from Let-out Property | ||||
| Monthly Rent (B) | 30,000 | 30,000 | 30,000 | 30,000 |
| Annual Rental Income (C )= (B)*12 | 360,000 | 360,000 | 360,000 | 360,000 |
| Municipal Taxes (D) | 10,000 | 10,000 | 10,000 | 10,000 |
| Net Annual Value (E)=(C ) – (D) | 350,000 | 350,000 | 350,000 | 350,000 |
| Standard Deduction (@30%) (F) = 30% % (E) | 105,000 | 105,000 | 105,000 | 105,000 |
| Interest paid on let out property (G) | 600,000 | 600,000 | 600,000 | 600,000 |
| Income From let out property (H) = (E) -(F)-(G) | (355,000) | (355,000) | (355,000) | (355,000) |
| Income From House Property (loss) (I) = (A) + (H) | (555,000) | (555,000) | (355,000) | (355,000) |
| Set off Permitted (J) | (555,000) | (200,000) | (355,000) | (200,000) |
| Net Taxable Income (K) = (X) + (J) | 14,45,000 | 18,00,000 | 16,45,000 | 18,00,000 |
| Tax liability (as per slab rate) | 266,255 | 375,950 | 328,055 | 375,950 |
| You lose on tax benefits worth (30% tax bracket) | NA | 109,695 | NA | 47,895 |
| *I have not accounted for tax benefit due to reduction in slab rate for income tax slab of Rs 2.5 lacs – Rs 5 lacs. This helps isolate the impact of the tax change better. | ||||
Who Bears the Worst Impact?
- Those who have purchased really expensive (second) houses on loan. You would expect loan amount and the interest payment per financial year to be higher.
- Those who are early into their loans for second houses. Outstanding principal amount and the interest outgo will be higher.
- Those who have multiple housing loans. You may have purchased many residential properties but you have a single cap of Rs 2 lacs.
- Those who have loan for self-occupied property running and have taken another loan to purchase a second house.
Those who have purchased their first house or are planning to purchase their first house on home loan, there is no change for them. Such buyers need not worry. Those who do not take loans to purchase property do not need to worry either. No loan, no confusion. They were anyways not availing any tax benefit.
What This Can Lead To?
At least some of us will feel short-changed with this move. If you took out a big loan to purchase a second or third property a couple of years back, you are likely to be miffed. However, in my opinion, this is a smart move by the Government. Though it is too early to say, I believe this will curb real estate investment demand. The cap on loss from Income from house property certainly increases the effective cost of loan and will dampen returns. This should discourage investment in multiple properties.
The Government may not be wrong in thinking that subsidizing purchase of second home is not its priority. You can very well ask what the Government has done to help people purchase their first homes but it is a question of political debate.
We also need to look at other budget proposals such as restriction of receiving any cash payment in excess of Rs 3 lacs for a single transaction. Or the notification of Benami Transactions Act in November 2016. It will increasingly difficult to park unaccounted wealth in real estate. This should curb investment demand.
I must say industry dynamics are not so simplistic. There will be many forces at play that will decide the impact of this move on investment demand. Or how a lower investment demand will affect property prices? After all, real estate developers have been somehow able to keep prices high for many years despite high inventories and abysmal financial health. Multi-pronged attack on black money and withdrawal of incentives for second properties may well just do that. Fingers crossed.
Disclaimer: I am not a tax expert. You are advised to consult a Chartered Accountant before you take any decision.
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