Your primer to house tax

Over the years, readers have been writing in with their queries relating to taxation with respect to house property. Therefore, this week, I have attempted to answer the same.
Determination of annual value

Determining tax due on property is complicated because this is the only income that the Income-Tax Act taxes on a notional basis. In other words, the tax is based not on the actual income per se, but on the inherent capacity or potential of the property to generate income — also known as its annual value.

A single self-occupied property is not chargeable to tax. If the taxpayer has more than one self-occupied house, then the annual value of any one house, at his option, can be taken as nil. The others will be assumed to have been rented out and taxed on a notional annual value. The option chosen by the taxpayer can change from year to year.

The next step is to see how the annual value is arrived at in the case of rented properties (or more than one self-occupied property). Here, annual value is taken as the higher of the actual rent received or the sum for which the property might reasonably be expected to be rented.

To determine the sum for which the property might be reasonably expected to be rented out, the higher of the municipal valuation of the property or the fair rental value of the property has to be chosen, taking into account its size and the area in which it is located.

However, if the property is governed by the Rent Control Act, the standard rent fixed thereof will have to be taken for determination of annual value. In a nutshell, the annual value of a rented property will be the higher of the municipal value or fair rental value, but restricted to the standard rent. However, if the actual rent received or receivable exceeds such amount, then such actual rent will be taken as the annual value. The table will make this point clearer.

Deductions available
From the annual value of the property as determined above, municipal taxes levied by the local authority can be deducted. However, such deduction is allowed only if the municipal taxes have been actually paid during the year. Taxes that are due but not paid are not allowed as deduction. However, taxes paid during the year are allowed as a deduction even if they relate to past or future years.

Thus, for each year, municipal taxes actually paid will be allowed as a deduction from the annual value. The value arrived at by deducting the municipal tax is referred to as net annual value. From this value, deductions detailed below are allowed under Section 24, and the balance is the taxable income under the head ‘Income from House Property’.

Section 24 offers two deductions. The first is a statutory deduction of 30% of the net annual value.  The second deduction is to do with interest payable on properties bought on mortgage. For rented properties (or where the deemed annual value is taxed in the case of more than one self-occupied property) the full amount of interest paid is allowed as a deduction.

Also, where a borrower raises a fresh loan in order to repay the original loan, the interest paid on the second loan would also be allowed as a deduction.  In the case of a self-occupied house, where the annual value is nil, the interest deduction is limited to Rs 1.5 lakh on loans borrowed after April 1, 1999 and Rs 30,000 on loans borrowed prior to that date.

Here, it may be noted that if the property is co-owned, each of the co-owner is entitled to the interest deduction of up to Rs 1.5 lakh. Plus, Section 80C deduction is available up to Rs 1 lakh on the principal portion of the EMI. This deduction too is also available to each co-owner.

Therefore, in the case of a husband and wife, if the property has been bought jointly, then an aggregate deduction of Rs 5 lakh would be available to them on their combined income.

Pre-construction period
Both the concessions, deduction for repayment of capital and deduction of interest are allowed only when the income from house property becomes chargeable to tax. In other words, the construction should be complete, the flat should be ready for occupation and the municipal annual value should be known.

The interest paid for the years prior to the year in which the property was completed is deductible in five successive yearly installments starting from the year in which the acquisition/ construction was completed and each of the four succeeding years. Note that the limit of Rs 1.5 lakh includes the current year’s interest as well as the installment of pre-acquisition/ construction period.

For example, say the pre-construction period interest amounts to Rs 5 lakh and the current year’s interest amounts to Rs 80,000. Now, Rs 5 lakh is to be spread over five years beginning from the year in which the construction is completed. So for that year, in the case of a rented property, the taxpayer can avail of a deduction of Rs 1.8 lakh (Rs 1 lakh + Rs 80,000) whereas in the case of a self-occupied property, the deduction would be limited to Rs 1.5 lakh.

The writer is director, Wonderland Consultants, a tax and financial planning firm.