Every Union budget comes with a few positive and negative announcements. In Budget 2017, there were a few positives on personal income tax front. Tax slab rate was reduced from 10% to 5% for the income tax slab of Rs 2.5 lacs to Rs 5 lacs. Holding period for long term capital gains in real estate transactions was reduced from 3 years to 2 years.
There were a couple of negatives too. Surcharge of 10% was introduced for those with taxable income between Rs 50 lacs and Rs 1 crore. There was another major announcement where a cap of Rs 2 lacs was introduced for the set-off of loss under Income from House property against other income heads.
Earlier, there was no such cap. This move can increase tax liability for those who have invested in residential real estate through home loans.
In this post, we will examine this proposal in detail and see how it affects your tax liability.
What is Income From House Property?
If you have given out a residential property on rent, you need to pay tax on the rental income. However, you are allowed a few adjustments to your rental income before you pay tax on the same.
Firstly, you can deduct municipal taxes paid.
Secondly, you are allowed a Standard deduction of 30% from the rental income. You will incur some charges for maintainence or regular upkeep of the property. Rather than going into specific charges and allowing deduction on actuals basis, the Government provides a flat 30% deduction.
Thirdly, if you have taken a home loan to purchase the house, you can also deduct interest paid towards such loan from the rental income.
Annual Rental Income – Municipal Taxes = Net Annual Value (NAV)
Income from House Property = Net Annual Value – Standard Deduction (@30% of NAV) –Interest on Home Loan
If the Income from House Property is positive, you pay income tax on the same at your slab rate.
If the Income from House Property is negative i.e. it results in a loss, you can set off this loss under Income from other heads (salary, other sources).
Please understand even if you have not given your house on rent, it may still be considered Deemed Let out property and you may have to pay tax on notional rent. The calculation in that case is slightly complex. For more on calculation of Income from House Property, you can go through this tutorial on Income Tax website. Section 22, 23 and 24 of the Income Tax Act cover Income from House Property.
What about Self-Occupied Property?
As per Section 23 of the Income Tax Act, net annual value of a self-occupied property is considered NIL.
Going back to the equation of Income from House property, if you have a housing loan, interest will result in loss under Income from house property.
The maximum deduction for interest payment that you can take for a self-occupied property is capped at Rs 2 lacs per financial year. Therefore, loss under Income from House Property (for a self-occupied property) is automatically capped at Rs 2 lacs.
There is no change to tax benefits for self-occupied property.
What has this Budget changed?
Earlier, you could set off the entire loss under Income from house property from other heads of income. There was no cap.
For instance, if your loss under Income from House property was Rs 6 lacs, you could have used it to reduce your taxable income by Rs 6 lacs and ended up saving income tax up to Rs 1.8 lacs.
Now, this set off is capped at Rs 2 lacs per financial year.
You can carry forward this loss (which could not be set off) for 8 subsequent years. However, this will not bring much relief (especially for a big loan amount).
How this affects you?
Let’s assume you have rented out a residential property that fetches you a rent of Rs 40,000 per month or Rs 4.8 lacs per annum. Assume you pay municipal taxes of Rs 20,000 per annum.
Additionally, you pay home loan interest of Rs 8 lacs per annum. This amount will keep varying in a home loan. Let’s keep the amount constant for the sake of simplicity.
Your annual taxable income (after all deductions but before adjustment for income from house property) is Rs 20 lacs. I assume this income does not include capital gains.
Net Annual Value (NAV) = Rs 4.8 lacs – Rs 20,000 = Rs 4.6 lacs
Income from House Property = NAV – Standard Deduction – Interest paid
= Rs 4.6 lacs – 30% of Rs 4.6 lacs – Rs 8 lacs
= – Rs 4.78 lacs
Since the income is negative, you have a loss under Income from House Property.
Before this tax change comes into force (April 1, 2017), you could have reduced your taxable income by Rs 4.78 lacs. Hence, taxable income goes down to Rs 15.22 lacs. Since you fall in 30% tax bracket, this would have resulted in tax-saving of Rs 1.43 lacs (before cess).
However, once this tax change comes into force from April 1, 2017, the set off is capped at Rs 2 lacs. In such a case, your taxable income will go down to Rs 18 lacs. Tax saving of only Rs 60,000.
Therefore, your tax liability will increase by Rs 83,400. The hit will be lower if you fall in 10% or 20% tax bracket.
Points to Note
- This cap is on set-off of Loss under Income from House property (and not on interest paid towards a housing loan)
- Tax benefit for self-occupied property has not changed (remains at Rs 2 lacs for interest payment). However, you must note that even self-occupied property may result in Loss under Income from House Property (if you have taken a home loan). So, if you have a home loan running for self-occupied property, it will eat into this pie of Rs 2 lacs.
- For instance, if interest on self-occupied property for the financial year is Rs 2.5 lacs, your limit of set-off of loss against other income heads is already finished. There is nothing left to adjust. If you have an additional loss under income from house property of Rs 4.78 lacs (as in the above example), you cannot get any tax benefit. You will have to carry forward this loss. In this case, your tax liability will be higher by Rs 1.43 lacs.
Who will not be affected?
If you have taken home loan for a self-occupied property only, nothing changes for you. Your tax benefit was and remains capped at Rs 2 lacs.
For other cases, it boils down to mathematics. You will have to do a bit of maths to figure out how this tax change affects you.
If the overall home loan amount (outstanding) is on the lower side (for both self-occupied and let-out properties, you may not have to take much hit.
Suppose you pay Rs 60,000 interest for self-occupied property and Rs 3 lacs interest for let-out property in a financial year. I assume annual rent is Rs 2.4 lacs and municipal taxes are Rs 5,000.
In this case, your loss under Income from house property will be Rs 1.95 lacs. You are well within your cap of Rs 2 lacs. Hence, you get the benefit for the entire interest paid.
Who takes the biggest hit?
Again, it is about mathematics. You will have to calculate for your case.
The set-off amount is capped. Hence, if you are paying a lot of interest on your home loans, you may lose out on tax benefits.
- If you have taken a loan for an expensive house purchase, you can expect loan amount and the interest outgo to be higher.
- If you have taken a home loan recently, you can expect interest outgo to be higher in the initial years.
- If you have a big loan outstanding on a let-out property, you will take a bigger tax hit. Bigger loan amount means higher interest outgo.
Reduction in tax benefits for let-out property will brings down post-tax returns for the investors, which can potentially curb investment demand. This should put downward pressure on property prices. Well, I feel I am making it sound too simplistic. It is never that simple and obvious. We will find out.
I am not a tax expert. You must consult a Chartered Accountant before you take any decision. In the post, I have talked about a budget proposal. The proposal becomes reality only once it is passed by the Parliament.