ITR filing for FY 2023-24: Taxing gains from real estate investments

One of the primary attractions of investing in real estate is the regular income it provides in form of monthly rentals.

Real estate has long been one of the more popular investment avenues. This asset class offers various ways to invest, such as residential properties, commercial spaces, rental properties, and real estate investment trusts (REITs) and so on. Each type of real estate investment can yield different forms of income, which are treated differently under tax laws.

For those who own real estate or are planning to invest, it is crucial to understand how income from these investments is taxed. Rental income, for instance, is typically considered part of your ordinary income and is taxed at your marginal tax rate. Meanwhile, profits from the sale of a property, known as capital gains, are subject to capital gains tax, which can vary based on the duration the property was held.

Additionally, there are various deductions and exemptions that can be claimed to reduce taxable income from real estate, such as standard deductions, indexation, home loan interest, and property maintenance costs and so on. Understanding these tax implications can help investors maximise their returns and ensure compliance with tax regulations. Therefore, before diving into real estate investments, it is essential to familiarise yourself with the tax treatment of different types of real estate income.

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Rental Income

One of the primary attractions of investing in real estate is the regular income it provides in the form of monthly rentals. On an average, residential properties typically offer a rental yield of 2-3 percent per annum, while commercial properties can deliver higher returns, ranging from 6-9 percent per annum.

However, “income earned from renting out property is subject to tax under the head "Income from House Property",” said Suresh Surana, practicing Chartered Accountant. But, the entire rental income is not taxable, there are certain deductions you can claim against it. “The net annual value of the property (gross rent minus municipal taxes) is calculated, and standard deductions such as 30 percent of the net annual value and interest on home loans can be claimed as deduction. The remaining income is added to the taxpayer's total income and taxed at the applicable slab rates,” said Surana.

For instance, if you earn Rs 5 lakh per year as a rental income, you can deduct 30 percent of Rs 5 lakh as a standard deduction (i.e., Rs 1.5 lakh). Additionally, if you have a home loan for that property and have paid Rs 1 lakh as interest during the year, this amount can also be deducted. Thus, your taxable rental income will be Rs 2.5 lakh (Rs 5 lakh minus Rs 2.5 lakh, which is the sum of the Rs 1.5 lakh standard deduction and the Rs 1 lakh home loan interest). You will then need to pay tax on the remaining Rs 2.5 lakh.

However, the tax treatment of rental income can vary if you own the property as a business asset. For example, if you own a property and run a hostel, the rental income from the property will be taxed under the head Profits and Gains of Business or Profession (PGBP),  “Income from property is taxed under the PGBP when the assessee is engaged in the business of letting out of property or the assessee occupies the property for the purpose of any business or profession carried by on him,” said Yeeshu Sehgal, Head of Tax Market, AKM Global, a tax and consulting firm.

If you own real estate as a business asset, the standard deduction is not available. Instead, you can claim various other related business expenses, such as maintenance, electricity bills, employee and upkeep cost and so on. “Under the head PGBP, there are no specific limits on deductions. All expenses incurred wholly and exclusively for the purpose of the business or profession can be deducted to arrive at the taxable income. Additionally, depreciation expense is also allowed as a deduction under PGBP,” said Sehgal.

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Dividend from REITs

Real Estate Investment Trusts (REITs) provide another avenue for investing in real estate. What makes REITs particularly attractive to a large number of people is the low investment threshold compared to physical real estate. You can invest as little as Rs 10,000 in REITs.

REITs are securities linked to real estate and can be traded on stock exchanges once listed. They are structured similarly to mutual funds, with sponsors, trustees, fund managers, and unit holders. However, REITs invest in income-generating physical real estate, owned in name of special purpose vehicle (SPV), and this income is distributed among the unit holders. REITs distribute income to investors in the form of dividend.

However, “the taxability of the dividends in the hands of unit holders of REIT would depend upon the taxing system opted for by the SPV,” said Surana.

“In case the SPV has opted to pay taxes as per the normal provisions applicable, the dividend received would be exempt from tax in the hands of investor or unitholders in accordance with Section 10(23FD) of the IT Act,” said Surana.

However, “If the SPV opts for payment of taxes u/s 115BAA of the IT Act, the dividends received by the unitholder from the REIT (which was received by the SPV) would be taxable in the hands of the unitholders as per your personal income tax slab rate, applicable to each unitholder,” added Surana.

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International real estate investments

Investment in real estate by Indians is not confined to India; many people also invest in properties abroad. In fact, Indians are among the largest investors in global cities like Dubai and London. People choose to invest in these cities for various reasons, including the potential for better returns. However, “taxation of returns from international real estate investments depends on the country's domestic tax laws where the immovable property is situated. Generally, the right to tax on property income falls in the hands of the country in which such immovable property is situated,” said Sehgal.

The tax rates may vary in the country where you invest, and any income from such investments will be taxed there first. You may need to file a tax return in India as well, but you can claim a deduction for the tax paid in the host country from your tax liability in India, provided there is a Double Taxation Avoidance Agreement (DTAA) between India and the country of investment.

Sehgal explain with example, let’s suppose Mr. A owns a flat in Dubai and gets some rental income out if it. Currently this income is not subject to tax since there is no personal tax in the UAE and also has a zero withholding at present. However, the rental income from the flat in the UAE shall be taxed in the UAE first if in future there is a tax levied on such income. As an Indian resident (Mr. A) can take the foreign tax credits of the taxes paid in the UAE, if any. Further, India had entered into various DTAA for more than 90-95 countries in order to avoid double taxation of income.

Before investing in real estate for regular income, be sure to consider these taxation rules. In the next part of this series, we will write about how capital gains from real estate investments are taxed when you exit your investments.