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How to Use Rental Income to Optimize Tax Benefits?

Submitted by admin on July 11th, 2024

Have you ever questioned if purchasing rental properties would be a prudent financial move? Even while the possibility of consistent income and capital growth is alluring, many people find themselves perplexed by the intricate tax ramifications.

Let’s examine how rental income is taxed in India, with a particular emphasis on properties acquired through loans, and how this information might help you with your post-tax returns.

Cracking the Code on Rental Income Tax:
In India’s tax code, rental income is classified as “Income from House Property.” Simply deduct permissible deductions from your gross rental income—the entire amount of rent you get each year—to determine your taxable income. Among these subtractions are:

All property taxes paid to the local government are considered municipal taxes.
Standard deduction: To cover upkeep and repairs, a flat 30% of your gross rental revenue is deducted.

Interest on loan: The amount of interest you pay back on a loan that you take out to buy or remodel your rental home.

Example: Determining Rental Property Taxable Income

Let us examine an example:

Rental Revenue: Thirty Lakhs
Property Worth: INR Five Crores
Interest on Loan: Six Lakhs

Applying the formula mentioned above:

30 Lakhs – (Municipal Taxes Paid + Rs. (30% of 30 Lakhs) + Rs. 6 Lakhs is the amount of Taxable Income.

This will result in your taxable income, which will then be subject to further taxation determined by the appropriate tax slab (let’s use a 30% slab plus 4% cess as an example). This corresponds to an estimated tax liability of Rs. 4.68 lakhs.

This is the thrilling part, though! Your rental property’s post-tax income might be quite appealing if you use tax deductions wisely. The post-tax return in this case is around 5%, which puts it in line with certain fixed-income assets like debt mutual funds and FDs. Additionally, there is a chance that the property value will increase.

The Power of Loan Deductions:

Using a loan to purchase a rental property has a secret benefit in that you may deduct the interest paid from your rental revenue. This is a wise financial decision because it drastically lowers your taxable income. Even if the loan principal payments doesn’t directly affect your rental income, it is still eligible for a Section 80C deduction, which would decrease your overall tax burden. To further maximize your taxable income, you can deduct any excess interest paid on your loan against other income up to Rs. 2 lakhs if your loan interest for the year exceeds your rental income.

Comparing Rental Properties with Other Asset Classes After Tax

The 30% standard deduction and the loan interest deduction allow rental properties to have effective tax rates that are typically lower than those of fixed-income assets like FDs and debt mutual funds. This might result in higher post-tax profits on your investment.

The Secret to Building Wealth is Knowledge:

Your investing plan may be greatly enhanced by being aware of the tax ramifications of rental income, particularly the advantages provided by standard deductions and loan interest deductions. To navigate the complexity of taxation and optimize your financial path, keep yourself informed and seek advice from 1 Finance and other skilled financial specialists.