Tax Treatment on ‘Income from House Property’ (Practical)

This advanced learning will cover advanced level topics to be kept in mind while computing income chargeable to tax under the head “Income from house property”. The general topics covering the manner of computation of income chargeable to tax under the head “Income from house property” have already been discussed and, hence, the same will not be repeated in the advanced learning material. However, readers are advised to refer to the study material as well as to case study before reading the advanced learning material. This will help them to recap the basic provisions and will enable them to understand the advanced topics easily.

The material covers following advanced level topics :

        Discussion on charging section i.e. section 22 with focus on meaning of various terms viz:

o          Building

o          Land appurtenant to a building

o          Owner

o          Deemed owner

o          Property used for the purpose of business or profession

        Tax treatment of composite rent :

o          Composite rent i.e. rent of building and charges for various services.

o          Composite rent i.e. rent of building and rent of other assets.

        Tax treatment when un-realised rent is subsequently realised.

        Tax treatment of arrears of rent.

1.     Charging Section-22 of the Act.

Section 22 of the Act is the charging section for taxing any income under the head “Income from house property”. The charging section reads as follows :

The annual value of property consisting of any buildings or lands appurtenant thereto of which the assessee is the owner, other than such portions of such property as he may occupy for the purposes of any business or profession carried on by him, the profits of which are chargeable to income-tax shall be chargeable to income-tax under the head "Income from house property".

Considering section 22, following are the conditions to be satisfied to tax any income under the head “Income from house property”:

        There should be a property consisting of building or land appurtenant thereto.

        The property should be owned by the assessee.

        The property should not be used by the owner of the property for the purpose of his business or profession, the profit of which is chargeable to income-tax.

Important points to be kept in mind as drawn from section 22

        Tax under this head is not levied on the rent of the property but it is on the capacity of a property to earn income. The basis of measurement of the capacity of property to earn income is “Annual Value” (i.e., Gross Annual Value). This fact can be confirmed from the charging section which says as follows :

“Annual value” of a property, consisting of building or land appurtenant thereto, of which the assessee is the owner, shall be charged to tax under the head “Income from house property”.

        Rental income of any property, being building or land appurtenant thereto, is only charged to tax under this head. Hence, rent of vacant plot is not charged to tax under this head.

        If the property being rented is building or land appurtenant thereto but the assessee is not the owner of the property, then the rental income will not be charged to tax under this head.

        It will make no difference whether renting is the business of the assessee or not. In other words, on satisfaction of above conditions, rental income from building or land appurtenant thereto will be charged to tax under the head “Income from house property”, even if the assessee is doing the business of renting of properties.

2.     Manner of computation of Income from house property (in case of let-out property)

The provisions relating to computation of computation of income chargeable to tax under the head “Income from house property” have already been discussed in study material and in case study (Day 6). However, for ease of reference the relevant portion of these provisions is reproduced below :

Manner of computation of income from house property in case of a let-out property :

(*) Gross annual value is determined in following three steps :

Step 1:           Compute reasonable expected rent of the property (Note 1).

Step 2:           Compute actual rent of the property (Note 2).

Step 3: Compute gross annual value (Note 3).

Rent pertaining to vacancy period is to be deducted from amount derived at step 3

Note 1

Reasonable expected rent will be higher of the following :

➣        Municipal value of the property; or

➣        Fair rent of the property.

If a property is covered under the Rent Control Act, then the reasonable expected rent cannot exceed standard rent. In other words, in case of a property covered under the Rent Control Act reasonable expected rent will be higher of the municipal value or fair rent subject to standard rent of the property.

Note 2

It is the actual annual rent for which the property is let-out during the previous year. While computing actual rent, rent pertaining to vacancy period is not to be deducted.

Treatment of unrealised rent while computing actual rent:

3.     Unrealised rent:

It is the rent of the property pertaining to the previous year, which the owner of the property could not recover from the tenant. If following conditions are satisfied, then unrealised rent pertaining to the previous year is to be deducted from actual rent of the previous year:

➣        The tenancy is bona fide.

➣        The defaulting tenant has vacated the property, or steps have been taken to compel him to vacate the property.

➣        The defaulting tenant is not in occupation of any other property of the assessee.

➣        The assessee has taken all steps to recover such amount, including legal proceedings or he satisfies the Assessing Officer that legal proceedings would be useless.

Note 3

Gross annual value will be higher of amount computed at step 1 or step 2.

Following important points should be kept in mind while computing annual rent of a property :

        Non-refundable deposit received from tenant is to be included in annual rent, i.e., rent received or receivable. Non-refundable deposit is to be added to annual rent on a pro rata basis.

        Refundable deposit cannot be added to annual rent. Further, notional interest on refundable deposit can be added to annual rent only if it is proved that such deposit is given to compensate for non-payment of rent or short payment of rent. Deposit taken for purposes like ensuring timely payment of rent, proper security of property, etc., cannot be added to the annual rent.

        Advance rent cannot be considered in rent received or receivable to be used for the purpose of computation of GAV.

4.     Deductions available while computing income from house property

Detailed discussion on various deductions available while computing income from house property is already provided in study material as well as on day 6 of programme. However, for ease of understanding the same points are once again discussed over here.

While computing income from house property, only following items can be claimed as deductions. It should be noted that any item other than following three items cannot be claimed as deductions while computing income from house property:

        Deduction on account of Municipal taxes paid by the assessee during the year.

        Deduction under section 24(a) @ 30% of Net Annual Value.

        Deduction under section 24(b) on account of interest on capital borrowed for the purpose of purchase or construction of the property.

5.     Deduction on account of Municipal taxes

Assessee can claim deduction on account of Municipal taxes levied on the property by any local authority. Municipal taxes are deducted from the gross annual value of the property. Deduction on account of Municipal taxes is available if following conditions are satisfied :

➣        Municipal taxes are borne by the owner; and

➣        Municipal taxes are actually paid by the owner during the previous year.

The remaining amount left after deducting Municipal taxes (from gross annual value) is called as “Net Annual Value”. Following is the manner of claiming deduction on account of Municipal taxes :

6.     Common mistakes made by the assessees while claiming deduction on account of Municipal taxes

Following are the few common mistakes made by the assessees while claiming deduction on account of Municipal taxes :

        Municipal taxes not paid upto 31st March, i.e., paid in next year. However, owner makes mistake by claiming deduction on account of outstanding Municipal taxes.

Example : Mr. Rahul has rented a building at a monthly rent of Rs. 84,000. Municipal taxes of the property for the year 2012-13 amounting to Rs. 25,200 are paid by him in April, 2013. In this case, Municipal taxes are not paid by him during the year 2012-13 but are paid in the next year. Hence, he cannot claim the deduction of Municipal taxes of Rs. 25,200 while computing income from house property for the year 2012-13.

        Municipal taxes paid by the tenant and the owner makes mistake by claiming deduction of taxes paid by the tenant.

Example : Mr. Kunal has rented a building at a monthly rent of Rs. 84,000. As per the rent agreement, the Municipal taxes of the property are to be born by the tenant. In this case, Mr. Kunal cannot claim deduction on account of Municipal taxes, since the Municipal taxes are paid by the tenant and not by the owner, i.e., not by Mr. Kunal.

        Municipal taxes pertaining to earlier year or Municipal taxes pertaining to future years paid in advance are not claimed by the assessee as deduction in the year in which they are paid. The assessee makes mistake by not claiming the entire Municipal taxes paid during the year. He may make a mistake by claiming only the amount of Municipal taxes pertaining to the year for which income from house property is being computed.

Example : Mr. Kunal has rented a building at a monthly rent of Rs. 84,000. During the year 2012-13, he paid following amount on account of Municipal taxes of the above property :

o          Rs. 25,200 on account of outstanding Municipal taxes pertaining to the year 2011-12.

o          Rs. 8,400 on account of Municipal taxes for the year 2012-13.

o          Rs. 28,400 on account of advance Municipal taxes for the year 2013-14.

In this case, while computing income from house property for the year 2012-13, Mr. Kunal can claim deduction of Rs. 62,000 on account of Municipal taxes (i.e., Rs. 25,200 + Rs. 8,400 + Rs. 28,400).

7.     Deduction under section 24(a)

While computing taxable income from house property, assessee is entitled to claim deduction under section 24(a). Deduction under section 24(a), commonly referred to as „standard deduction‟, will be equal to 30% of the net annual value. Deduction under section 24(a) @ 30% of net annual value is available, whether or not the assessee has incurred any expenditure.

8.     Common mistakes made by the assessees while claiming deduction under section 24(a):-

Deduction under section 24(a) is available whether or not any expenditure is incurred by the assessee in respect of house property, like repairs, insurance, etc. Assessee may make a mistake by claiming actual expenditure on account of repairs, insurance, etc., instead of flat deduction at 30%.

Example:

Mr. Kapoor has rented a flat at a monthly rent of Rs. 84,000. During the year 2012-13, he had incurred following expenditure in respect of the property rented by him :

        Rs. 25,200 on account of repairs of the property.

        Rs. 8,400 on account of insurance premium.

        Rs. 12,520 on account of society‟s maintenance charges.

In this case, while computing income from house property, he cannot claim deduction of any of the above items. However, irrespective of the amount of expenditure incurred by him, he can claim a flat deduction under section 24(a) at 30% of the Net Annual Value.

9.     Deduction under section 24(b)

While computing taxable income from house property, assessee is entitled to claim deduction under section 24(b). Deduction under section 24(b) is available in respect of interest on capital borrowed for the purpose of purchase, construction, repair, renewal or reconstruction of the property. Interest on capital is deductible on accrual basis (irrespective of the method of accounting followed by the assessee).

Deduction of interest is classified into two forms, viz., interest pertaining to pre-construction period and interest pertaining to post-construction period. Post construction period interest is the interest pertaining to the previous year (i.e., the previous year for which house property income is being computed). Pre-construction period interest is explained below:

Pre-construction period interest is allowed as deduction in five equal annual instalments, commencing from the previous year in which the house property was acquired or constructed. Pre-construction period is the period commencing from the date of borrowing of loan and ends on the earlier of the following:

➣        Date of repayment of loan; or

➣        31st March immediately prior to the date of completion of the construction/acquisition of the property

In case of let-out property, interest is deductible without any limit. However, in case of a self-occupied house property, interest is deductible subject to maximum limit of Rs. 1,50,000 or Rs. 30,000. If the following conditions are satisfied, then limit in respect of interest on borrowed capital will be Rs. 1,50,000:

➣        Capital is borrowed on or after 1-4-1999. However, the construction can start even before 1-4-1999.

➣        Capital is borrowed for the purpose of acquisition or construction (i.e., not for repair, renewal, reconstruction).

➣        The acquisition or construction is completed within 3 years from the end of the financial year in which the capital was borrowed.

➣        The person extending the loan certifies that such interest is payable in respect of the amount advanced for acquisition or construction of the house or as re-finance of the principal amount outstanding under an earlier loan taken for acquisition or construction of the property.

If any of the above condition is not satisfied, then the limit will be Rs. 30,000.

10.   Common mistakes made by the assessees while claiming deduction under section 24(b)

        Deduction on account of interest is available on accrual basis. Hence, interest pertaining to a year which is paid in the next year is also deductible. Assessee may make a mistake by not claiming deduction of the amount of interest which is not paid during the year but is paid in the next year.

Example

Mr. Kapoor has rented a flat at a monthly rent of Rs. 84,000. The flat is purchased by him from a bank loan. Interest on bank loan for the year 2012-13 amounted to Rs. 2,52,000. Interest of Rs. 2,52,000 pertaining to the year 2012-13 is paid in April, 2013. In this case Mr. Kapoor can claim deduction under section 24(b) of Rs. 2,52,000 in respect of interest on loan taken to purchase the flat. It should be noted that for the year 2012-13, Mr. Kapoor can claim deduction under section 24(b) of Rs. 2,52,000, even though interest for the year 2012-13 is paid in the year 2013-14.

        Deduction under section 24(b) on account of interest is available only if the assessee has borrowed the funds and he is paying the interest. Many times property is co-owned by two or more persons (like property jointly owned by husband and wife or by brothers or by father and son/daughter). In such a case, the co-owner can claim deduction on account of interest under section 24(b) only if he has borrowed the funds to acquire the property. If the property is purchased by one co-owner from his own funds and by another co-owner from bank loan, then in such a case, the co-owner who has borrowed funds can only claim deduction under section 24(b). The co-owner who has acquired the property through his own funds cannot claim deduction under section 24(b) merely because his name appears as a co-owner.

Example

Mr. Rahul and Mr. Sunil are co-owners/joint owners of a flat (50% share each). The flat is given on rent to a company at a monthly rent of Rs. 84,000. The property is acquired through a bank loan and loan is sanctioned in the name of both the co-owners. Both the co-owners are paying the installments by sharing each instalment equally. In this case, Mr. Rahul can claim deduction under section 24(b) of 50% of the amount of interest and Mr. Sunil can claim deduction under section 24(b) of 50% of interest pertaining to his share.

Suppose in the above case, Mr. Rahul has taken bank loan to buy the property and Mr. Sunil has contributed the amount from his own funds. In this case, deduction under section 24(b) can be claimed only by Mr. Rahul, since he has taken loan to acquire the property. No deduction under section 24(b) is available to Mr. Sunil, since he has not borrowed any amount to acquire the property.

        Deduction under section 24(b) on account of interest is available only if the assessee has borrowed the funds and he is paying the interest. Many times, in case of property jointly owned by two or more persons, loan is borrowed by one co-owner and the installments are paid by another co-owner. In such a case, the co-owner repaying the loan cannot claim deduction under section 24(b), since he is not the borrower and the co-owner who is the borrower cannot claim deduction under section 24(b), since he is not repaying the loan.

11.   Meaning of building :

For the purpose of this head, building should be considered as a permanent structure covering a space of land and used for variety of purposes like dwelling or store house or some other purpose. Following points should be noted in this regard:

        Building does not include mere wall, fence, monument, hoarding or similar structure, though designed for permanent use where it stands.

        Building does not include steam boat, ship or other vessel of navigation. Incomplete house or house which is in ruins without a roof and without doors cannot be called a building.

        A temporary structure will also be treated as a building if it satisfies the criteria of being treated as a building.

12.   Meaning of land appurtenant thereto, i.e., to a building

Land appurtenant to a building is generally a land that is an indivisible part of a building and is used for enjoyment of the building and not put to any other use. Thus, land appurtenant to a building will cover approach roads connecting the building to public streets, play ground, backyard, kitchen garden, motor garage, coach home, parking area, etc.

13.   Meaning of the word owner

For the purpose of charging income under this head, the word owner will cover a person who can exercise the rights of the owner. However, a person exercising rights of owner on behalf of any other person will not be treated as an owner for the purpose of this head. Following points should be noted in this regard:

        A person purchasing a property who is entitled to enjoy the rights of owner will be treated as an owner for the purpose of this head even if the registered document has not been executed in his favour.

        In respect of a building constructed on leasehold land, the owner of the building will be treated as the owner for the purpose of this head, even though he is not the owner of the land on which building is standing. The position will remain same even if the building is to be transferred to the lessor on completion of the lease.

        Following persons will be treated as deemed owners and rental income from property will be taxed in their hands :

(1)       If an individual transfers his or her house property to his/her spouse (not being a transfer in connection with an agreement to live apart) or to his/her minor child (not being married daughter) without adequate monetary consideration, then the transferor will be deemed as owner of the property.

(2)       Holder of impartible estate is deemed as the owner of the property.

(3)       A member of co-operative society, company or other association of persons to whom a building (or part of it) is allotted or leased under house building scheme of the society, company or association is treated as deemed owner of the property.

(4)       A person acquiring property by “power of attorney” transaction by satisfying the conditions of section 53A of the Transfer of Property Act, will be treated as the deemed owner (although he may not be the registered owner). Section 53A of the said Act prescribes following conditions:

(a)        There is an agreement in writing.

(b)       The purchase consideration is paid or purchaser is willing to pay it.

(c)        Purchaser has taken the possession of the property.

(5)       In case of lease of a property for a period exceeding 12 years (whether originally fixed or provision of extension exists), lessee is deemed to be the owner of the property. However, any right by way of lease from month-to-month or for a period not exceeding one year is not covered by this provision. {Section 269UA(f)}

14.   Property used for the purpose of business or profession

Income from a property which is used by the owner for his business or profession is not charged to tax under this head. Following points should be noted in this regard:

        Where letting out is subservient and incidental to the main business, rental income will not be charged to tax under this head.

        Income from property rented to the employees will not be charged to tax under this head.

15.   Special cases to be noted while computing income chargeable to tax under the head “Income from house property”

        If tax incidence is attracted under section 22 in respect of a property situated in foreign country, annual value will be computed as if the property is situated in India.

        In respect of property held as stock-in-trade or in case of assessee engaged in the business of letting out of property, income will be taxed under the head “Income from house property”. However, if letting out of property is incidental to the main objective of business, rental income will be taxed under the head “Profits and gains of business or profession”.

        If the property is owned by co-owners (i.e., owned or deemed to be owned by more than one person), and the share of each co-owner is ascertained, then share of each such co-owner is charged to tax individually (and not as an association of persons) in the hands of each co-owner.

16.   Tax treatment of composite rent

Following different situations may arise in case of composite rent (i.e., building rented along with other assets or provision of different services along with building):

(I) Renting of building and provisions of other services

In such a case composite rent includes rent of building and charges for different services (like lift, watchman, electricity supply, etc.). In this situation, composite rent is to be split up and the sum attributable to the use of property is to be assessed under the head “Income from house property” and charges for various services will be taxed under the head “Profits and gains of business or profession” or “Income from other sources” (as the case may be).

(II) Renting of building and other assets:

In such a case, composite rent includes rent of building and rent of other assets. This situation can further be classified as follows:

(a)        Letting out of building and letting out of other assets are non-separable (i.e., both the lettings are composite and not separable) (e.g., letting out of equipped theatre). In this situation, entire rent is taxed under the head “Profits and gains of business or profession” or “Income from other sources”. This rule is applicable even if rent of both lettings is fixed separately.

(b)       Letting out of building and letting out of other assets are separable (i.e., both the lettings are separable) (e.g., letting out of bike along with building). In this situation rent of building is taxed under the head “Income from house property” and rent of other asset is taxed under the head “Profits and gains of business or profession” or “Income from other sources” (as the case many be). This rule is applicable even if the assessee receives composite rent for both the lettings.

17.   Tax treatment when unrealised rent is subsequently realised

For taxation purpose unrealised rent which is subsequently realised can be classified as follows:

(A) When unrealised rent pertaining to assessment year 2001-02 or any earlier assessment year is subsequently realized:

When un realised rent pertaining to assessment year 2001-02 or any earlier assessment year which was allowed as deduction (in assessment year 2001-02 or earlier assessment year) is subsequently realised, then the amount so realised will be taxed (in the previous year in which it is received) under the head “Income from house property”. Such an amount will be charged to tax without allowing any deduction. Such an amount is charged to tax even if the property is not owned by the assessee in the year of recovery/receipt of unrealized rent.

Unrealised rent pertaining to previous year 2001-02 or subsequent year is subsequently realized: