For taxpayers who have an outstanding home loan, the interest paid on these loans helps them reduce tax liability under the current income tax structure. However, under the new income tax regime proposed in Budget 2020, interest paid on the home loan is not deductible for independent homes. But for taxpayers who have rented their homes, there is good news. Interest paid on a home loan taken out for rented property can be deducted under section 24 (b) even under the proposed new tax regime.
Budget 2020 proposed a new tax regime with lower tax rates as well as the elimination of almost all deductions and exemptions. A taxpayer had the option of switching to this new regime for the 2020-2021 fiscal year or to continue with the existing income tax structure. While most tax breaks are not available in the new tax system, tax relief on interest paid on home loans for rental property can still be claimed.
Here’s everything you need to know about claiming this deduction in the proposed tax system, and what to watch out for when claiming this deduction.
- Rent / Deemed Rent Home Ownership
If you have rented real estate and are receiving rental income, then you can claim mortgage interest paid on that property to be deducted from the rental income earned. Thus, even under the new tax regime, owner taxpayers can claim tax benefits from the interest paid.
Here is the benefit homeowners can claim under the proposed new tax regime:
- They can claim a 30% flat-rate reduction on net rental income. Net rental income would be the total rental income (i.e. the greater of expected rent or rent received / receivable) in a fiscal year minus municipal taxes paid during the fiscal year
- After claiming the standard deduction mentioned above, they can deduct the interest paid on the mortgage taken out for the leased property.
The final value obtained after deducting the standard deduction and the interest paid on the home loan would therefore reduce the taxable income of real estate property and help reduce the overall gross total income and the final tax payable.
- Independent house property
Taxpayers should keep in mind that the new tax regime does not allow deducting mortgage interest paid for independent real estate. However, under the current tax regime, deduction of mortgage interest paid for an independent home ownership is allowed up to Rs 2 lakh, resulting in reduced tax payable.
Let us understand this better with an example: you own two homes and you both have outstanding home loans. One house is used by you for your own living and another house is rented. In such a scenario, the interest paid on your home will not be eligible for deduction under the new tax regime. On the other hand, you can claim the deduction on paid home loan interest and the standard deduction on rental income from the second house.
What should you watch out for?
Although the mortgage interest deduction is in favor of the owners, however, care must be taken in claiming such a deduction. There are two rules in the new tax system that are a step back in case you incur a loss on the ownership of your home (i.e. the interest payment exceeds the rental income). These are the following –
Loss compensation: If the interest paid on the mortgage in a financial year exceeds the rental income received, there would be a loss in income from real estate property. This loss cannot be offset by any other income item such as salary, interest income and capital gains, etc. according to the rules of the new tax regime. Therefore, you cannot further reduce your taxable income with the loss you incurred on your home ownership. Under the current tax regime, however, compensation for loss of real estate up to Rs 2 lakh is permitted.
Carry forward losses: In accordance with the 2020 finance bill, the loss of the rented building cannot be carried over to subsequent years under the new tax regime. However, a different point of view is given in the memorandum of the 2020 finance bill according to which it is stated that a taxpayer can carry forward losses of a rented property to subsequent years in accordance with the law in force.
In our opinion, the 2020 finance bill will prevail over the memorandum which does not allow the carry-over of property losses in the new regime. A clarification from the government would be welcome in this regard.
So, if you have real estate that has been rented out, you can claim a standard deduction as well as a deduction for mortgage interest paid on net rental income. However, you need to be careful in the event of a loss. In such cases, the old tax regime may be more advantageous. As the new regime is optional, calculate your tax liability on your real estate income under the two regimes and then choose the regime that offers you the maximum tax advantage.
(The author is Founder and CEO of Tax2win.in – an RTI repository website)