Must know financial facts about Rental Income

Rental-income

Real estate is an essential asset class everyone would like to have on their financial portfolio. Some of us are gifted with funds and loan options that can have us invest in a residential or commercial property for rental income. Owning a rental property also enables an individual achieve desired financial goals.  Investing in real estate for wealth creation and receipt of rental income has its fair share of risks and management.

A real estate property can be acquired in different forms, such as a residential apartment or home, warehouse, commercial complex/isolated shops, office buildings, storage units or warehouses. Capital appreciation is a great benefit you enjoy when you invest in real estate apart from the rental income you get. Assess factors like the investment amount, the profile of the tenant, risks involved, the annualised returns and the exit time before you make a decision. First, let us look at all the key things we need to keep in mind before making an investment in real estate for rental income.

Investing in a local/town/ metro: Return and appreciation on Real estate investment depends a lot on where you invest. Investing locally as you feel confident of the local real estate trends or investing in big cities like Mumbai will determine the rental income and the capital appreciation of the property. While investing locally will give you the security and ease of visiting the property often for maintenance; investing in an outstation property can be great for capital appreciation. Uptown or big city properties are always in demand because of the residential or commercial needs of the population in the city/town.

Cash Flow: Letting out your property for franchise to well-established brands like pizza outlets or coffee shops is a very lucrative option and you also get a part of their profits apart from the rental income.  Contract terms for profit –sharing or rent depends on the brand’s policy and your negotiations for profit-sharing or rental income.

Location: The location of your real estate property decides the capital appreciation or rental income. A residential property close to a school or near a central location in the city always attracts tenants due to its location. There is also a never ceasing demand for the property through- out the year.

Maintenance: Any type of real estate property requires maintenance. Ensure that you have all of it covered in the rental income you receive. Giving the property a new coat of paint or repairs related to plumbing and electricity have to be budgeted accordingly.

Period of possession: This is one big question that you must answer to yourself even before you purchase the property. Have you invested in the property to keep it for 20 years or more (which is considered long-term) or do you want to sell it in the next boom and buy again in recession? Get yourself sorted on these key questions before you set yourself to invest.

What’s the tax outlook on Rental Income?

Ensure that you do not over or under –report your rental income. Rental income is also subject to deductions like municipal taxes and a standard deduction of 30% from the net annual value.

This income falls under the head, ‘income from house property’ if the rent received is from residential property and treated as business income if the property has been let out for commercial purposes- home stay, service apartments, shops, franchise outlets all come under this head. An investor can claim deductions under both heads depending on the quantum of income and expenses.

The improper disclosure of rental income has the investor missing out on claims. If the property is your second home and is not fetching any rental income it is still treated as a ‘deemed to be let out’ property and the investor will have to pay tax after claiming a deduction on the interest paid if any, on the loan availed to purchase the property.

Tax Computation on Rental Income: Take a look at the tax computation on rental income.  The annual rental income from the property is valued at the highest of the below three values:

Gross Annual Value = Highest among Rent received or receivable; Fair Market Value or Municipal value.

Your Net Annual Value is the GAV less Municipal Taxes. A deduction of 30% is allowed on the NAV towards maintenance charges.

Let us assume your rental income from a property let out for residential purposes is INR 20,000/- per month.  You have paid INR 12,000 as municipal taxes that year and the interest you have paid towards borrowed capital is INR 55,000/-

Income from House Property Amount
Value of annual rental income 20000 * 12 = 2,40,000/-
Less Municipal taxes 12,000
Net Annual value 2,40,000 – 12000 = 228000/-
Deductions Under Sec 24  
228000 – (30% as maintenance- 68400) = 159600  
Deduction : Interest on borrowed capital 55000

 

Income from house property = 159600 – 55000 = 1,04,600/-

Making the call to invest in a second home or property for wealth creation is  good. But ensure the returns and capital appreciation justify the investment.

Source : ET Wealth, Business Standard, Money market.

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