Let your 2nd house pay for itself
Rajeev Lal, 29, works as general manager with computer
company LeadComp in Pune. In January 2005, he bought a second house in the city
for Rs 17.5 lakh (Rs 1.75 million). He is a prime example of India's urban
affluent, who are buying second houses as their incomes are rising and banks are
pushing home loans at reasonable rates. Plus, the real estate boom is giving
them numerous options on the kind of house to go for and where to buy it.
Level the cash flows
But buying a second house is just the beginning of the story. Once bought, a
property creates its own stream of financial outflows. For most apartments, one
would at least have to pay municipal taxes as well as a maintenance fee for
common areas and services, like cleaners and power back-up, provided by the
housing society. If the property has been bought with a loan, there would be
principal repayments and interest payments.
Unless you are planning to stay in it, it is likely that you are looking at
investing in property in expectation that its value will appreciate over a
period of time. So, while the big inflow may happen at the end of your
investment horizon, there should be current inflows to at least partially ease
the burden of current outflows. That is where renting it out comes in.
Loan repayment: The rent can take care of a large chunk of the
installments you would be paying if you have bought the property with a loan. In
fact, that is exactly what Lal has done. "The rent is Rs 12,500 a month, which
takes care of my EMI of Rs 14,000 to a large extent," he says. The security
deposit can be invested and the income from it can help cover the gap between
the EMI and the rent, unless the tenant defaults on rent payments.
Why you
should rent |
To lighten the outflow load:
- - Of loan repayment
- - Of municipal taxes
- - Of society maintenance charges
- - Of internal upkeep of the house
To save on
taxes:
- - Since you will have to pay tax on a
'notional' rent from the house even if you leave it vacant.
- - Since the entire amount paid as
interest is - deductible from income
- - Since the entire amount spent on
maintenance is deducted from income
- - Since a negative net income from the
house can be offset against total
income
|
Maintenance charges: Society maintenance charges vary from one to the
other. Most of the time, however, the tenant would be taking care of the
maintenance charges as he would be using the facilities.
Cost of the internal maintenance of the house would depend on how much care a
tenant takes of the property. On an average, one per cent of the house value can
be set aside for this. While Lal, for instance, decided to put in the security
deposit money in a mutual fund, other owners might like to keep that amount of
cash handy in case they need to repair any damage. Even when a destructive
tenant leaves the house in shambles, a forfeited deposit can help get it back in
shape.
Bottom line, renting it out can make a second house pay for itself - almost.
Tackle the taxman
Letting out a property not only helps level the cash inflows and outflows, it
makes sense from the taxation angle, too.
Income tax: The income tax department does not treat your second house
as a self-occupied one, even if you use it or leave it vacant. The taxman will
assume it is 'let out' property, that is, you are earning rent from it. "The tax
department requires that you pay tax on the notional rent, that is, the annual
rental value," says Harsh Roongta, CEO, Apnaloan.com. It has been specifically
provided in the Income Tax Act that you will be taxed on the higher of the
actual rent received or notional value.
The glitch is, the methodology for deciding the notional rent varies from
state to state. However, it is usually fixed depending on the municipal value of
the property and the annual rental value of similar properties in the area. For
instance, in Safdarjung Enclave area of south Delhi, the notional rent of a
1,350 sq. ft apartment would be around Rs 12,000 per month.
One advantage of a second house is that, unlike a self-occupied house, the
entire amount paid as interest on a home loan, even if it is more than Rs
150,000, can be deducted from the pre-tax income.
Also, the amount spent on repairing and maintaining the second house is
allowed as deduction from the income. So, you will finally pay taxes on the net
income from the second house, which is annual rent (higher of actual and
notional) reduced by municipal taxes, standard deduction (30 per cent of annual
rent net of municipal taxes) and interest on home loan.
In the example above, let us assume that the property has been left vacant by
the owner, who pays income tax in the highest slab. If he has not borrowed to
buy the house, he may end up paying around Rs 30,000 a year (after adjusting for
municipal tax and deduction) as tax on income that he does not earn.
If, however, the net income is negative, it can be set off against income
from other such property. The remaining loss, if any, can be set off against any
other income.
Wealth Tax: One residential property in your name is exempted from
wealth tax. However, if you own two houses in your name, you would have to pay
wealth tax. Says Roongta: "When you own two houses, you may also have to pay
wealth tax if the value of the house that has been treated as not self-occupied,
net of the loan taken for it, along with other assets chargeable to wealth tax
exceeds Rs 15 lakh (Rs 1.5 million)." The wealth tax is one per cent of the net
wealth, exceeding Rs 15 lakh.
"It is prudent to rent out as gains are immense," advises Rajiv Bajaj,
managing director, Bajaj Capital. "That's the only way he can derive maximum
benefit out of this investment strategy," he asserts.
Do the due diligence
While the case for renting out your second house is strong, make such a move
only after you are sure about the people you are renting it out to. Make direct
contact with your would-be tenant. Even if a property broker is involved,
personal contact will let you understand the person.
"Any rent agreement which is for a period of more than 11 months needs to be
registered" for it to have any legal validity, says Delhi-based legal expert
Kamal Agnihotri. For that, the agreement has to be done on stamp paper. Always
consult a lawyer before getting into an agreement.
Whether you are renting out to a company or an individual, verify the
credentials of the tenant, especially when the house is not close to the place
where you stay. According to Rishi Awasthi, a Delhi-based lawyer: "It is
advisable to lease out to companies as they normally do not voluntarily violate
the terms of contract."
So, if you have decided that real estate is what you like investing in, rent
it out for an efficient portfolio.
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