If you choose to use the capital gains from selling your house to buy a residential property, you will not be taxed and there is no tax liability from such a sale as stated under Section 54F of the Income Tax Act.
You can also be exempted from tax if the long term capital gains or profit from the sale is invested for a period of 3 years in specific bonds of National Highways Authority of India or Rural Electrification Corporation Limited as stated under Section 54 EC.
We discuss here what you need to know about computing taxes on the rental income for a house and the capital gains from the possible sale of a house is taken up for discussion in this article.
A. Tax on Rental Income from a property
When you own two houses and let out one of them for rent, you receive an income for which you need to pay tax. In such a scenario, the taxable income from the total rent income received by you for that particular financial year will be computed in your tax returns.
How your rental income is computed
For rented out properties the gross rent needs to be the greater of the three values below:
a. Municipal valuation of the property – The rental value fixed by the corporation based on your locality and property value.
b. Actual rent received during the financial year – The rent received by you from your tenant for that particular financial year.
c. Fair rent – The rent of a similar property in the same or similar locality.
From this gross rent, the property tax is deducted to arrive at the net annual value of the rental income.
Deductions possible from the net annual value of the rental income:
1. 30% of the net annual value for repair, maintenance and rent collection expenses for the property
2. Interest paid towards any type of home loan on this particular property.
3. Any property insurance premium you have paid for the financial year.
Here is a simple example:
Actual rent received from property – Rs. 15,000 x 12 =1.8 L
Less: Municipal Tax/Property Tax paid by you – Rs. 5,000
Balance: i.e. Net Annual Value -Rs. 1.75 L
Less:
(1) 30% of the net annual value – Rs. 52,500
(2) Interest paid on a renovation loan for the house – Rs. 30,000
=Taxable rent income =Rs. 92,500
The taxable rent income will be included by your auditor under income from other sources, along with other such incomes as well as your salary income and deductions you are eligible for, to calculate your final tax outgo.
B. Capital gains tax on selling a property
Let us also quickly consider what happens if you decide to sell your property.
Any profit that you receive by selling any asset at a price higher than at which it was acquired by you is classified as capital gain and clubbed under income from other sources.
Short term and long term capital gains
If you sell your house within 3 years from the date of purchase you will incur a short term capital gain or loss which is included under other sources of income.
In case you sell your house beyond three years then it is considered as a long term capital gain/loss.
Exemptions from capital gains tax
If you choose to use the capital gains from selling your house to buy a residential property, you will not be taxed and there is no tax liability from such a sale as stated under Section 54F of the Income Tax Act.
You can also be exempted from tax if the long term capital gains or profit from the sale is invested for a period of 3 years in specific bonds of National Highways Authority of India or Rural Electrification Corporation Limited as stated under Section 54 EC.
In case you do not choose to make any investments and opt to pay tax, the income is calculated using the indexation method which is nothing but accounting for the effects of inflation.
For example, if you had purchased a house for Rs 5 L and then sold it for 9 L, the capital gain would be Rs 4 L. However, for the sake of income tax calculation a number called indexation number is used which is a percentage of the gain that is assumed as value addition due to inflation.
Thus if indexation is 20% then only Rs. 3 L (Rs 9L – 20% of 5 L + 5 L =Rs 3L) would be taken as capital gain. A capital gain is usually charged @20% in most cases where the calculation is based on indexation.
A better understanding of the tax rules can make your life easier and help you file your tax returns with clarity.