Think twice as that second home won’t save much tax

While the Budget has let sellers of immovable property claim long-term capital gains after two years instead of the earlier three, it has discouraged investment in the housing sector for rental income by taking away a benefit provided on buying a second house.

Tax breaks on interest paid on rented homes (whether first or second) have now been capped at Rs 2 lakh a year. So far, the entire payment of interest on home loan taken to buy a house for investment purpose was allowed to be set off from the gross income. The only condition to avail the facility was that the rental income was included in the total income.

In fact, this provision will take away a major avenue to avoid paying taxes by creating assets. At present, the interest cost of a house is around 9% of capital value, while rental income is at best 2% of capital value. Therefore, the investor gets a deduction of almost 7% of capital value from taxable income. If the investor is in 30% tax bracket, the saving is over 2% of capital value each year.

In fact, a senior CA pointed out that this would be a major setback for high-net worth individuals who have invested in real estate. He felt that even though the additional interest -above Rs 2 lakh paid during the year -can be set off in the next eight assessment years, this won’t be of much use as the interest payments would mount every year.

There was some reason for cheer though. The Budget has reduced holding period for property from three years to two years. Now if you sell it after two years, the profit will be taxed at 20% after indexation. Indexation takes into account the inflation during the holding period and accordingly adjusts the purchase price, thereby reducing the tax burden for the seller.

For those who want to sell their ancestral houses, the base year for indexation will now be taken as 2001, instead of 1981. This will inflate the base price for those houses which were purchased earlier. With the increase in base price, the net capital gains will reduce, and so the tax liability will come down. This provision will enable investors to book profit faster.