Tax on rental income and applicable deductions

[ecis2016.org] While income tax laws prescribe certain taxes on a person, who receives any rent from a property which he has let out, the tax payer is also allowed to claim certain deductions out of such income. We examine the legal provisions

Tax on rental income is a concept using which governments across the world levy taxes on the rental income of landlords. However, to encourage real estate investments, they also offer tax deductions against tax on rental income.

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Tax on rental income

There is an income you make while earning rent. Across the world, the beneficiary of such an earning has to pay tax on rental income.

Is rental income taxable in India?

As is true of any income, the concept of tax on rental income is also used in India. If proper planning is not put in place, a large part of your rental income could be lost in paying taxes. Your tax burden can be lowered, by availing of the deductions offered under the tax laws in India.

Tax on rental income India

The rent that the owner generates, is considered as income under the existing laws in India. Consequently, one earning such income, the landlord is liable to pay tax on rental income in India.

How income tax on rental income is calculated?

The Income Tax Act of India has a specific head of income, titled ‘Income from house property’, to tax the rent received by an owner of a property.

What is income from house property?

According to the Income Tax Act, rental income of a property – this could be a building and the land adjoining it – is taxed under Section 24 in the hands of the owner, under the head ‘income from house property’.

So, any rent received with respect to a property that is let out, is taxable under this head. Rent received with respect to a residential house, as well as commercial property, is taxable under this head. Even the rent received for letting out your factory building or rent received on land appurtenant to the building, is taxable under this head. 

Recall here that amid a large number of companies opting for remote working in the aftermath of the coronavirus pandemic, a large-number of white-collar workers have moved back to the cities of their origin, making a severe impact on the rental incomes of the landlords in big cities.

Also read how to claims tax deduction under 80GG is HRA is not part of your salary.

Under which section is income from house property taxed?

 According to the Income Tax Act, rental income of a property is taxed under Section 24 in the hands of the owner, under the head ‘income from house property’. However, the rent earned by letting out vacant land is not taxed under this category, but is taxed under ‘income from other sources’. Income from house property is charged only on land which forms part of a building.

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Even though the rent generated from shops is also taxed under the same head, in case the property is being used for business or to carry out professional services by the owner, this section will not be applicable.

So, if you let out a property for a nominal amount, the amount to be considered for taxation of such property, would be the market rent and not the rent that you have received. Likewise, if the actual rent received by you for your property is higher than the market rent, the rent actually received/receivable by you, will be considered for taxation purpose. Please note that the rental income becomes taxable in your hand on accrual basis and not on receipt basis.

It is only the owner, who is taxed for rent received. Hence, if you sublet any property that you have taken on rent, the amount received would become taxable under the head ‘Income from other sources’. Even the rent received by a person who has encroached on a property, would become taxable under this head. The ownership for this purpose is broadly defined and even covers cases where you have received possession of a property in part performance of an agreement and where the legal title of the goods may not have been transferred in your name. Even when an individual gifts the property to one’s spouse, except under an agreement to live apart, he shall continue to be treated as an owner of the property and taxed accordingly, even though he may not have received the actual rent for such property. Similarly, even if the property is gifted to a minor, the donor parent shall continue to be taxed for such property.

Check out ecis2016.org’s tool to generate rent receipt for income tax

How much rental income is taxable?

It is not that the gross rent received becomes taxable.

From the rent received/receivable for the property, you are allowed to deduct the municipal taxes payable for the property. As the rent is taxable on accrual basis, the law allows you to claim deduction for the rent which you have not been able to realise, subject to the fulfilment of certain conditions. After deducting the above two items, what you get is the annual value, from which you are allowed a standard deduction of 30% of the annual value, to cover the expense for repairs, etc.

Please note that the deduction of 30% is a standard deduction, irrespective of whether you have actually incurred any expenditure for repairs or renovation for the property, during the year under review.

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How much rent is tax-free?

In case you have borrowed any money for the purpose of purchase, construction, repair/renovation of the property, you are also allowed to claim deduction for the interest payable on money so borrowed. The money can be borrowed from any person and not necessarily as a home loan. Presently, there is no restriction on the amount of interest, which you can claim against your rental income.

However there is a ceiling of Rs two lakhs, for loss under the head ‘Income from house property’, which can be set off against your other income, likes salary, business income or capital gains. Any loss under this head, beyond Rs two lakhs, is allowed to be carried forward for set off, during eight subsequent years. This provision adversely affects people who borrow money to buy a property and let it out, as rental values are generally around three to four per cent of the capital value, whereas the rate of interest on such loans is around nine per cent. As home loans are usually taken for longer periods, the situation of loss under this head, will normally continue for longer periods and the excess interest beyond Rs two lakhs will, effectively, be lost forever.

Tax implications on rental income post-Coronavirus

In the aftermath of the Coronavirus pandemic, a large number of tenants, working in various industries of the big cities, have moved back to their own places, since remote working is now the norm. Those who are still living in their previous rented accommodations, have also asked their landlords to waive a certain portion of the rent, because of the financial difficulties caused by the pandemic. Since the rental income of a large number of landlords has hence been impacted, there is hope that the government will issue guidelines, as to on what basis their rental income should be taxed now.

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Latest news updates

No tax on unrealised rent, rules ITAT

December 3, 2020: In a move that comes at a major relief for landlords amid rising instances of rent defaults, an income-tax appellate tribunal has ruled that they are not liable to pay taxes on unrealised rental incomes. According to the order by the tribunal, the fact that the tenant has deducted tax cannot be the sole reason for taxability of rent.

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The recent ruling by the Mumbai bench of the Income Tax Appellate Tribunal (ITAT), which clearly states that tax on rental income is only applicable when the rent is actually received, will have a direct bearing on all cases where tenants have not been able to pay the rent, because of the ongoing Coronavirus-induced economic stress amid a sharp fall in employment numbers.

The order by the bench came while delivering its verdict in a case where a tenant had deducted TDS (tax deducted at source) on the rent amount without paying the rent to a Navi Mumbai-based apartment leasing company.

Even though the ruling by the Mumbai branch of the tax tribunal comes pertaining to a case in 2011, the order might have a huge impact on ongoing instances. According to audit firm Deloitte India, tax payers with similar facts may want to evaluate the impact of this ruling in their respective cases.

The background

The company entered into a rental agreement with the tenant for its property at Vashi, Navi Mumbai. The tenant made the payment of rent, as well as reimbursement of electricity expenses regularly up to financial year (FY) 2009-10, corresponding to the assessment year (AY) 2010-11. However, owing to financial constraints, the tenant did not make any payments towards rent from FY 2010-11, corresponding to AY 2011-12. Subsequently, the tenant did pay some portion of the rent for FY 2010-11, corresponding to AY 2011-12. The tenant vacated the premises in November 2011.

At the same time, the tenant made deducted TDS on rent payment and deposited the same into the government account while no rent was received by the tax payer for FY 2011-12, corresponding to AY 2012-13. Therefore, the tax payer did not disclose such rental income in its income-tax return.

While the assessment officer added the unrealised rent to the total income of the tax payer, the commissioner of income tax (appeals) upheld the AO’s order when the tax payer appealed against it. Following this, the matter reached the Mumbai bench of the ITAT.

“The rental income could be brought to tax only when the tax payer had actually received or was likely to receive or had certainty of receiving (rent) in the near future. In the given case, the tax payer had no certainty of receipt of any rent,” the Mumbai Income Tax Appellate Tribunal ruled.

“The fact that the tenant had deducted TDS and declared the same in the TDS return, alone could not be the reason to sustain the rental income,” it added.

Charitable trusts are not eligible for standard deduction on rental income

In February 2020, the Delhi branch of the Income Tax Appellate Tribunal ruled that charitable trusts are not eligible to claim standard deductions under Section 24 (A) out of the rental income chargeable to tax, as they claim capital expenditure at the time of property acquisition.

Tax on rental income from REITs

REITs or the Real Estate Investment Trusts are like mutual funds, wherein investors get a chance to invest in commercial real estate assets and get the advantage of the rent that these assets generate, without buying the physical asset itself. REITs are becoming popular in India as the rental yields and rental income is quite high on commercial properties, as compared to other types of properties. The tax on rental income of commercial properties is quite simplified, as far as REIT laws are concerned.

As per the regulations, around 90% of the taxable income is distributed among the investors or the unit holders of the REITs. This distribution is made mandatory by law. The investors receiving these distributions also enjoy tax exemptions.

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