Real estate investment: Homebuyer must look into taxation aspects of rental income, gains from property sale
An individual who has earned long-term capital gains on the sale of real estate can claim an exemption under Section 54 if he reinvests the gain in another property.
The rental income will be taxed as income from house property and added to the total income of the owner
If a taxpayer sells the property after 24 months, then the income will be treated as long-term capital gains
A taxpayer can buy two properties on sale of one property and still be eligible for exemption
Purchasing real estate is usually a long-term investment strategy, where an investor usually holds it for an extended period. The investor may later plan to sell it or rent it out to help earn an income. Rental income and gains from the sale of the assets are treated differently for tax purposes. It is important to understand the tax treatment of both these types of income will help make a decision about whether as an investor, you should sell, purchase or invest in real estate.
Let's deep dive into such situations in which the tax is levied on holding or selling the property:
1) In case the property is rented out
If the property in question is rented out, then the owner of such a property will have to pay tax on the rental income earned in a financial year (FY). The rental income will be taxed as "income from house property" and added to the total income of the owner. In case of an individual or Hindu Undivided Family (HUF), the tax will be levied on this rental income based on the slab rates.
While calculating income from house property, an individual can claim the following benefits:
a) Property tax, if paid in the FY, gets reduced from the rental income.
b) Standard deduction of 30 percent from the rental income calculated after reducing property tax.
c) Home loan interest paid during the year is allowed as a deduction under Section 24B.
d) Pre-construction interest paid can be claimed in five equal instalments starting from the year in which the construction of the property is completed.
e) Principal repayment of the home loan under Section 80C (maximum up to Rs 1.5 lakh).
f) Stamp duty and registration charges are also allowed as a deduction under Section 80C, subject to a maximum of Rs 1.5 lakh.
Also, if a property is sold within five years of the end of the financial year in which it was purchased, some tax benefits claimed earlier are reversed. The deductions claimed for the principal repayment, stamp duty and registration under Section 80C are reversed, and the amount is taxed in the year of sale. Only the deduction of the home loan interest payment under Section 24B is left untouched.
2) In case when the property is sold
If the property is transferred/sold within 24 months of buying or acquiring it, any profit earned from the transaction will be treated as short-term capital gains; this will be added to the owner's total income and taxed according to the slab rate applicable.
Similarly, if a taxpayer sells the property after 24 months, then the income will be treated as long-term capital gains; this gain is taxed at 20 percent after indexation. Indexation is nothing but the adjustment of the purchase price of any assets according to the inflation during the holding period. Indexing the acquisition cost of the property will slash the tax burden for the seller. Various exemptions such as Section 54, 54EC or 54F are available in case of long term capital gains, but no such benefit is provided for short-term capital gains.
While calculating long-term capital gains, a taxpayer can add the expenses incurred on repairs and renovation of the property and index them according to the year in which they were incurred.
Exemption available on sale of real estate under Section 54
An individual who has earned long-term capital gains on the sale of real estate can claim an exemption under Section 54 if he reinvests the gain in another property. The amount of exemption allowed is the lowest of long-term capital gains earned and the amount invested in the new property. To avail this exemption, an individual should have held the new property for more than two years.
The exemption under Section 54F has been extended on 1 April 2019 to two residential house properties, if the long term capital gains do not exceed Rs 2 crores. It means a taxpayer can buy two properties on sale of one property and still be eligible for exemption. This benefit can be availed once in a lifetime by an individual.
The owner selling his property should acquire the new property within two years. If the new property is under construction, then the construction must be completed within three years. It is mandatory that the new property should be situated in India.
In case the taxpayer is unable to invest the whole amount of capital gains, then he will have to deposit the remaining amount in a Capital Gains Account Scheme (CGAS) to claim its exemption under Section 54. This must be done before the due date of filing the tax returns of the financial year in which property was sold. He can later use this amount to buy a property. If he fails to utilise this amount within three years, then he will have to pay tax on the profits, which were earlier exempted, at the end of three years.
(The writer is founder & CEO, ClearTax)
The Property Owners' Association- which represents 2,700 property owners controlling at least 10,000 buildings in Mumbai - will file a writ petition in the Bombay High Court before 20 April challenging the new property tax bill.
Stamp duty is the transactional tax collected by the government on property purchases. Stamp duty collection is one of the largest contributors to a state's revenue