Tax on rental income depends on owner's business

For individuals, the safe option is to offer rent as income from house property

Classifying the rent you receive from a property can be confusing when filing income tax (I-T) returns. The money received can be included in the section ‘income from house property’, ‘income from other sources’ or even be classified as ‘business income’ if the owner’s primary business is letting out property.

The classification has a significant impact on your tax outgo. If it’s income from house property, the owner gets deduction for maintenance on 30 per cent of the total rent received. He can also deduct the property tax he pays. But, many would prefer to show their rental income as business income, as there is no cap on the deduction for maintenance; owners get to claim depreciation, and when it’s vacant they don’t need to pay tax on ‘notional’ rent. “The law does not provide clear guidance on when an individual can classify rent as business income. The courts have ruled that only if the owner is engaged in the business of letting out properties can he classify it as business income,” says Sudhakar Sethuraman, partner, Deloitte Haskins & Sells.

Thin line of demarcation: If you rent the property as an individual or as a company, in most cases you need to mention the rent under the section called ‘income from house property’. It doesn’t matter whether it’s a house (residential) or an office (commercial). Even if you have a portfolio of properties that you let out, the rent would still be classified as income from house property. “It depends on whether the asset is being exploited commercially by renting out or whether it is being rented out for the purpose of enjoying rental income. The latter is always income from house property,” says Naveen Wadhwa, general manager, Taxmann.com.

To classify the rent as business income, individuals and business owners also need to have detailed documents which show renting properties is their primary business. Say, an individual has a building where he runs a paying guest (PG) accommodation. To classify the rent as business income, his agreement with the tenants needs to be worded accordingly; he needs to brand the accommodation; the property needs to be advertised accordingly, and so on. Experts say because rent classified as business income impacts tax collection, the I-T department could go into details to check if the property owner’s claim is backed by relevant documents.

If the PG property is a part of your company, similar paperwork is required. In addition, your company’s article of association and memorandum of association should also say that renting out property is the entity’s business. If the taxpayer has only a flat or two and runs a PG accommodation in these, the rent should be offered as income from house property for tax purposes. The same is true if you let out your property on rental apps such as Airbnb, where guests pay you based on the rate. If you want to opt for the safest route, offer rent as income from house property.

When tenants let out property: For a taxpayer to include rent as income from house property, he needs to be the owner. But, if you are a tenant who sub-lets, it means you don’t own the asset. “In such a case, the rent would be classified as income from other sources or business income, depending on the situation,” says Suresh Surana, founder, RSM Astute Consulting Group. The taxation of income from other sources is the same as that of business income — the taxpayer can deduct all the expenses incurred. But, if it’s an individual sub-letting a property, he needs to justify it. In case he cannot, it’s better to classify it as income from house property.

Segregate services from property: There are times when a property owner offers assets or services with the premises. Assets can be furniture, machinery and so on. Services include housekeeping, security, liftman, etc. In such cases, the taxation of property depends on whether the services or assets can be segregated. “In a case where letting out of a building and the assets is inseparable, the entire composite rent is charged to tax as profits and gains of business and profession or income from other sources, as the case may be,” says Chetan Chandak, head of tax research, H&R Block.

In a case where the property and other assets and services are separable, the rent portion will be income from house property. The assets and services will be offered as income from other sources or business income. This rule is applicable even if the owner receives composite rent for both. If the tenant pays a combined rent for the two (property and assets) but they can be segregated, they should be offered to tax separately.