When concession is a penalty

The new optional tax regime is likely to become the only one available in a few years. This will affect real estate

The trend in Budget 2020 seems to be towards a reduction in tax rates in lieu of giving up exemptions and deductions. Currently, it is only an option for individuals, but the direction is clear. This affects many industries such as real estate and insurance. 

In case of real estate, the impact of limiting interest deduction up to Rs 2 lakh has had a detrimental effect. For example, if a person takes a loan of Rs 1.4 crore to buy a property for Rs 2 crore. His rental income would be around 2.4 per cent or Rs 4.8 lakh a year. He will pay 8 per cent on his home loan or Rs 11. 2 lakh a year. So, renting out would mean a loss of Rs 6.4 lakh a year. Of this, he can offset Rs 2 lakh as interest income under Section 24(b). This loss can be carried forward but is lost if there is no real income from the property in future. If the property is self-occupied, his actual loss is the entire interest cost minus Rs 2 lakh, and the balance interest is not even allowed to be carried forward.

This brings into focus the so-called ‘concession” of allowing the rental value of self-occupied property being allowed to be treated as nil. Due to this concession, the deduction for home loan interest was restricted. The original provisions were introduced in 1960s when rental yields were 6-7 per cent a year. Few owned a house and taking home loans was unheard of.  

Allowing owners who stayed in their own houses to treat the annual income as nil was a real concession in those days, especially since the deductible expenses were not high. To ensure this “concession” was not misused, this treatment was restricted to one self-occupied house. A second self-occupied house was taxed as if it had been rented out. 

Later, more people started borrowing. As the number of people who started claiming interest deduction increased, the amount of deduction was restricted to the one self-occupied property. Meanwhile, the rental yields fell to around two per cent, and since interest costs were high, it always resulted in a loss even after considering a deemed rental. Taxpayers discovered that the so-called tax disadvantaged second “self-occupied property” was a significant advantage. So many started buying second properties. To plug this loophole, the overall allowance of loss on house property was restricted to Rs 2 lakh. The whole “concession” thing had come full circle now. 

Allowing a full deduction for the expenditure of interest in the year in which it is incurred while taxing the rental derived from the property is not a “concession”. In any case, not even allowing such disallowed interest expenditure to be deductible at the time of final sale of the property is entirely unjustified. The finance ministry should look into allowing this legitimate demand from the real estate industry to enable the deduction of interest in some form and not club this with other “deduc­tions/exemptions” that are being phased out.

The writer is a Sebi Registered Investment Advisor