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The following question was asked by Shashaank in the comment section of the post: 8 tax considerations to know before investing in property.

I have around 15 lacks in hand...is buying property with added loan the best decision, i pay around 40k income tax per annum apart from declaring 1 lack under 80c.My age is 25 and i am open to any other kind of investment.

Here’s the reply:

Shashaank,

Yours is a typical case of the classic dilemma (to buy or not to buy a house) faced by every young men with a bank balance of a few lakh rupees. Conventional advice is to buy a home early in life. But as usual I can only offer unconventional wisdom.

From what I can gather from your comment, all you have is Rs 15 lakh and you want to invest the entire savings to buy a house and financing the balance with a home loan. May be you think that property is a great investment (amazing returns without any accompanied risk) or, it might be that you want to avail tax breaks available on the housing loan in addition to saving rent (rent is a waste of money!) or probably the temptation is due to current low rates of interest (teaser rates) available on home loans.

Please don’t make such a mistake. You’re very young and I don’t think you should be in such a hurry to buy a house. Following points needs consideration before you arrive at a decision:

1. Return on property investments: A lot of people remain under the impression that property is a great investment just because land is the only asset with a limited supply on the earth and till we’re able to discover another habitable planet, the land prices can go only in upward direction.

Another related wider misconception is that property investment is lot easier (just approach a property dealer) and safer (no downside risk) than other asset classes like equities and mutual funds.

May be that they have never heard of US housing bubble. Understand that property as an asset class behaves in similar fashion to other asset classes like equities, gold and commodities. Put another way, real-estate market also moves in cycles (boom-and-bust) just like stock markets (what goes up must come down!).

2. Tax breaks on home loans will no more be available in future if DTC (direct tax code) is implemented in its current form.

3. Interest is an additional cost borne by you. Further, there are lots of other indirect costs associated with buying a house e.g., brokerage, loan processing fees, stamp duty and registration, municipal taxes, maintenance charges, repair charges, loan insurance charges and house insurance charges which significantly impact your true cost of ownership of a house.

4. Unlike other asset classes investing in property has long term implications.

5. Real estate is the most illiquid asset. Ask yourself following questions: What if there’s an emergent need for funds in the future? What if there is another recession and a salary cut? Or, what if you face a job crisis in future due to any other reason? What if there’s a significant drop in the real estate prices and the lender invokes “Depreciation of security” clause? What if interest rates rise and there is downturn in property prices at the same time? What if you have to change the city due to transfer or change of job?

6. You’ve not mentioned the value of the house and / or the amount of borrowing you’re planning. But let me tell you that excessive debt is not good. It is considered risky to borrow money to invest in stocks but not in property. Why? Isn’t it a case of financial leverage when we borrow money to invest in property? Don’t we also say that companies with debt on their balance sheets are more risky than the others? The point to note is that excessive leverage is bad irrespective of the purpose.

It is better to finance an asset out of your current savings rather than future income. Do you know the main cause behind US subprime crises? Although banks are ready to finance even up to 80-85% of the property value (in fact, lenders often encourage you to go for the maximum possible loan amount), it is always prudent to restrict your debt exposure to lowest possible level, in any case not more than 40-50% of the value of the asset and 50% of your net monthly savings (your take home pay less your monthly expenses). The purpose is to continue savings and investing to meet other financial goals and also keep a buffer for unexpected expenses & life style inflation.

Furthermore, as almost all banks and hosing finance companies are currently offering teaser loans so one has to also keep a safety margin for the imminent future increase in the EMI. So first understand how much loan you can really afford over a period of 20-30 years? You can calculate your loan affordability (& not eligibility) based on the maximum EMI you can afford to pay (as discussed in the previous paragraph) assuming a rate of interest around 2-3% more than the rate you are currently offered by using Loan affordability calculator.


No doubt, it is the dream nurtured by every young man to own his own house at the earliest. But as the above analysis shows it is better not to make this most important investment decision in a hurry and take adequate safeguards to reduce the likelihood of decision backfiring on you later.

Finally, it’s not about real estate vs. equities. In other words, the point of discussion is not whether investing in real estate is better than equities / other asset classes or vice versa. These are both different asset classes having their own pros & cons. The point is one should first have some investments in other asset classes, then buy a house for living (& not investing) as per your needs (& not wants), and after that even if you got some extra money, you might think of investing in real estate.

So Shashaank, first have some comfortable savings level. Your first priority should be to build a healthy investment portfolio by investing in debt (PF, PPF, NSC, Bonds, NCDs, Debt funds), equity (direct investing / diversified equity funds, index funds, ETFs) and gold based on your financial goals, risk profile and time horizon and then after some years you can go for your dream house. Remember—Buy in haste, repent in leisure.

In a nutshell, buy a right house at the right time and for the right purpose.

Do you agree? Please don’t forget to tell me about your decision.


Also see:

1. Housing Loan Queries
2. Why do you need a savings plan?

Read more

Are you planning to purchase a property in the name of any of your relative (except spouse and unmarried daughters) to avoid tax implications or for any other reason? Please don’t, because it is a benami transaction and is illegal. The property can be confiscated by the government and you could be put behind bars. Moreover, in future if something goes wrong, you the beneficial owner cannot file a suit against the benamidar (the ostensible owner) to recover the property from him.

According to Benami Transactions Prohibition Act, 1988, benami transaction is one in which property (both moveable and immoveable) is transferred to one person for a consideration paid or provided by another person. In other words, “Benami transactions” are purchases made in somebody else’s name (ostensible owner/benamidaar), who does not pay and merely lend his/her name, while the real title vests with another person who actually paid for the property (beneficial owner).

Good news is that as of now, the 20 year old act remains only in books and is still to come into operation because the necessary rules for implementing it has not been framed by the government.

The unique features about this act are that it is one of the briefest statues with just 9 sections and further even after 2 decades it is still lies dormant.

But very soon it is going to be a reality because the government is trying to strength the law by completely rewriting and resurrecting the Act with a purpose to clamp down on benami property transactions which are quite rampant in our economy.

Therefore, if you’re contemplating purchase of property in the name of any other person, consider all the legal provisions so that you don’t commit an offence unwittingly.

However, there is a way out. Instead of going for benami transaction, you can transfer the property by way of gift which is perfectly legal. But before making a transfer by way of a gift, remember the following points:

1) In case you gift money to a non-relative, it will be treated as income of the donee (with certain exceptions) under section 56(2)(v) of the Income Tax Act.

2) If you gift property, it won’t be treated as income of the donee (as gifts in kind are exempted), but will be subject to stamp duty and registration charges in case of an immovable property.

3) Finally, the income from the transferred asset will be clubbed in your hands in certain specified cases under section 64 of Income Tax Act.

Also Read: 8 Tax Considerations to Remember before Buying a Home

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AT the outset, let me clarify that there is no direct relationship whatsoever between claiming HRA tax exemption and claiming tax breaks on home loans (interest deduction under section 24(b) and principal repayment under section 80C). There are separate provisions in the income tax Act, 1961, for each of the two and one does not influence the other. Depending upon the particular facts and circumstances, you may or may not be able to claim both the benefits.

For claiming HRA tax exemption under section (u/s) 10(13A) of Income Tax Act, 1961, read with rule 2A of Income Tax Rules, the only condition is that you should be living in a rented accommodation for which you should be paying rent. Now, if you stay in your own house, you can’t pay rent to yourself and therefore the whole of the HRA received by you becomes taxable.

However, there still remains a possibility that even if you own a house, you stay in a rented accommodation/any other accommodation. It can be due to following reasons:

1. You've rented your own house while you stay in a rented accommodation
In such a case you'll be entitled for HRA tax exemption. However, rental income from your own house will be taxed in your hands while allowing interest deduction under section 24(b) and deduction for principal repayment under section 80C.


2. Your own house remains unoccupied while you stay in any other accommodation due to employment/business/profession reasons
You may stay at a place – it may be a different city or a different location within the same city - different from the place where your own house is situated.

Here there are two possibilities:

a. Rented accommodation i.e., you're paying rent
In this case, you can claim HRA tax exemption while your house will also be treated as self occupied house property for purpose of income tax and you'll get all the housing loan tax benefits i.e., both interest deduction u/s 24(b) and principal repayment under section 80C.

b. Non-rented accommodation i.e., you're not paying rent As the rent is not being paid, the question of HRA tax exemption does not arise. However, your house will be treated as self-occupied and you'll get the housing loan tax concessions (i.e., interest deduction under section 24 and deduction for principal repayment under section 80C).

3. Your house remains unoccupied while you stay in any other accommodation due to any other reason whatsoever (other than professional/employment/business reasons)

Here again, there are two possibilities:

a. Rented accommodation i.e., you're paying rent
In such a case, although you'll be entitled for HRA deduction, your own house loses the status of self-occupied property and will be treated as deemed to be let out, and thus its notional rental income will be taxable in your hands.

b. Non-rented accommodation i.e., you're not paying rent
For instance, for your personal convenience you live with your parents in their house while your house remains unoccupied. Here, if you don’t pay any rent, you're not entitled for HRA deduction.

Further, your own house won’t be treated as self-occupied for tax purposes.In other words, your own house will be treated as deemed to be let out and its notional rental income will be taxable in your hands.

However, irrespective of tax status of house i.e., whether self-occupied/deemed to be let-out/let-out, you'll continue to get the interest deduction on home loan under section 24(b) and deduction for principal repayment under section 80C.

4. The new house is not in your name. It belongs to any of your relative (spouse/parent’s) and you actually pay rent to the owner of the house.
In such a case also you'll be entitled for HRA tax exemption but the owner of the house who may be your spouse or parent(s) is assessable for the rental income derived from the house. Also, remember that it should a genuine transaction and not a colourable device to evade tax.

However, there is a difference of opinion among tax experts regarding payment of rent to spouse. According to one opinion, there is nothing wrong in paying rent to a spouse so long as it is not a sham transaction. The other view is that there can’t be any commercial transaction between husband and wife.

I tend to agree with the second view and therefore recommend that it is prudent not to indulge in such a dubious transaction which can be questioned by tax authorities and entangle you in legal disputes. Otherwise also, it is always better to err on the side of caution.


Conclusion
In a nutshell, if you've a house, either stay in it or rent it out. Don't leave it vacant. In case you have to leave it vacant, it should be only for employment/business/professional reasons. Even in such a case you should be either living in a different city or at different place within the same city, and not in the immediate vicinity of your house (i.e., the location where you stay should be at a considerable distance from your own house). Otherwise, notional rental income of your house (even if it is the only house you own) becomes taxable in your hands although you continue to get the interest deduction on housing loan u/s 24(b) and deduction for principal repayment of loan u/s 80C.

Furthermore, as regards the HRA, you will be getting the tax exemption under section 10(13A) so long as you are staying in a rented accommodation and actually making the rent payment, irrespective of whether you are having your own house(s) or not.

Finally, If you would like know how to calculate HRA tax exemption, please read How to Calculate HRA Tax Exemption and if you've any query regarding HRA tax exemption, please read How to claim HRA Tax Exemption - Tips & FAQs.

Also see:

1. 10 Smart Tips for Making the Most of Section 80C Deductions

2. Home Loan: Tax Queries

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“The hardest thing in the world to understand is the income tax.”

– Albert Einstein

OF COURSE, tax provisions are a bit complex, but so is life.

This blog is making an attempt to simplify the complex tax laws and present them before you in an easy-to-understand manner.

Here is a list of eight tax points you need to keep in mind before making a decision to invest in a house:

1. Notional rental income of second home is taxable
In case you are buying your second house, remember that its notional rental income is taxable even though you use it for your own self-occupation because for tax purposes only one house is allowed for self occupation and all others are deemed to be let out. Therefore, although there won’t be any income, you will still be asked to pay tax on notional rental income.


2. Wealth tax is applicable on more than one house
If you own more than one residential house, you are liable to wealth tax.

A residential house (subject to exemption of one) is considered as an asset under Wealth Tax Act, 1957 and you are liable to pay wealth tax in case your net wealth including the residential house(s) is more than Rs 15 lakh.

However, in case the residential house(s) is let-out for more than 300days in a financial year (FY), it is not considered as an asset for the purpose of wealth tax.

Furthermore, commercial property is also completely exempt from wealth tax, that is, you can own any number of commercial properties without worrying about wealth tax.


3. Interest benefit not allowed till the house is acquired/constructed.
Pre-acquisition/Pre-construction period interest is also allowed but only after acquisition/construction is complete. It is allowed in 5 equal annual instalments starting from the FY in which acquisition/completion is completed.

It is pertinent to note the following three points:

a) In case of a self-occupied house property, the total allowable interest in any FY cannot exceed Rs 1.5 lakh even after including the 1/5 portion of pre-construction/ pre-acquisition period interest.

b) The interest for whole of the financial year (FY) in which completion / acquisition is completed is treated as current interest. For instance, let’s say you borrowed money in January 2007 and got the house completed in the month of March 2008. In this particular case, only interest for the period Jan’07 to Mar’07 will be treated as pre-construction period interest and will be allowed in 5 equal annual instalments starting from the FY 2007-08. If instead of Mar’08, the construction of the house got completed in, say, May’08 then the interest up to Mar’08 will be treated as pre-construction period interest. In other words, you will start getting interest deduction benefit only from the FY 2008-09 instead of 2007-08.

c) There is no such condition under section 80C for allowability of principal repayment i.e., as soon as you start repaying the loan you are entitled for deduction for the principal part of the EMI under section 80C, irrespective of completion of acquisition or construction.

4. Acquisition or construction after 3 years from the end of FY in which capital borrowed
In case you are not able to complete the acquisition/ construction within a period of 3 years from the end of the FY in which money is borrowed, then the maximum limit of Rs.1,50,000 gets reduced to Rs 30,000. This restriction is applicable in case of self occupied house property only. In other words, the ‘let out’ or ‘deemed to be let out’ properties are allowed the actual interest paid without any restriction, even if the acquisition or construction is delayed beyond 3 years.


5. Interest is a cost borne by you
If you are going for home loan just to save on taxes even though you can self finance it, please remember that interest – like tax – is a cost borne by you.


6. In case of joint loans, co-borrowers need to be co-owners
In case you have gone for joint loan to increase the loan eligibility, remember that it is essential for co-borrowers to be co-owners in order to claim tax benefits.


7. Buying a plot of land
As vacant land is not considered a house property; therefore, there are no income tax implications, that is, from income tax point of view, you can invest in any number of plots without having to bother about income tax.

However, you also lose the tax breaks in case loan is only for the purpose of buying a plot of land.

Moreover, under Wealth Tax Act, 1957, urban land is considered an asset except for the exemption provided to one plot of land measuring not more than 500 sq. meters in area. But remember that this exemption is available only if you are not claiming any residential house to be exempt. In other words, if you already have a residential house which you are claiming as exempt, then you can’t claim a plot of land to be exempt under Wealth Tax Act.


8. Selling before 5 years
If you are buying the house for investment purposes and intend to sell in the very near term, just remember that if you sell it before the expiry of 5 years from the end of the FY in which possession is obtained, in addition to LTCG/STCG, the tax deduction under section 80C which you availed in all the earlier FYs will be deemed as your income.


Also See:

1. Section 80C - 10 Smart Tips
2. 4 Ways to Claim HRA & Home Loan Tax Benefits
3. Section 80C - Tax Saving Options
4. Home Loan Interest Rates - Fixed vs Floating
5. Home Loan Tax Deduction - Section 80C vs 24(b)

Read more