Should you invest in a Second Home or not?

Here are some of the points which indicate whether you should invest in a Second Home or not:

Should you invest in Second Home?The Union Government has come out with the Budget 2017 in full force. It’s sent repercussions in all the directions. Especially when it comes to buying second home, individuals witnessed good and bad news. On the sunnier side, affordable housing has got infrastructure status. It will provide developers cheaper sources of finance. The allocation towards Pradhan Mantri Awas Yojana has also been increased. Efforts are thus being made to ensure a roof over every family.

So, does that imply an ensuing boost in the real estate?

Well, it’s a bit difficult to answer!

Along with incentives, a slew of measures has been announced that would curb the chemistry that Indians shared with real estate. If you look at the restrictions imposed on a number of deductions that can be claimed on buying the second home, the situation is getting dicey.

But, on the contrary, the measure directed at capital gains on the sale of house property seems merrier.

Meanwhile, let’s check out the repercussions the Budget is going to have on your tax incidence.

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Set-off & carry forward of losses & Interest on Home Loan

While calculating income from house property, you are allowed to claim certain deductions. The deductions are by way of municipal taxes, a standard deduction of 30% and interest paid on the home loan. After adjusting the rental income for deductions, you may arrive at zero or negative income from house property. It’s regarded as “Loss from house property”.

This loss could be set off against other income heads like salary. It would have reduced your tax liability to a great extent.

However, the set-off of losses is treated differently in the case of rented property and self-occupied property. Earlier, for the self-occupied property, the maximum amount of loss that could be set-off was Rs 2 lakh. But no limits were specified for rented properties or second home.

Now as the new Budget becomes effective from 1 April 2017, the upper limit of losses for the second home has been fixed at Rs 2 lakh. It implies that the government has brought about a parity among both the category of properties. Although the unadjusted losses can be carry forward for 8 assessment years; but the adjustment is allowed only against the head income from house property.

The impact of Budget 2017 can be illustrated in the table given below:

Should you invest in Second Home?

So, the budgetary impact is very much conspicuous. Although the government has allowed carrying forward of losses for 8 years; but the extent of unadjusted losses would be so vast that the tax benefit would be negligible.

Treatment of Capital Gains on Sale of House Property

Earlier, the capital gains from the sale of house property within three years of buying were treated as short-term capital gains. Thus, these were taxed as per the income slab of the assessee. Suppose a person falls in the higher tax bracket of 30% and makes a gain of Rs 5 lakh from the sale of house property which he bought 3 years ago. He would have to pay a tax of Rs 150000 (excluding surcharge & cess) on such transaction.

However, the recent Budget announcement has brought smiles on the face of the HNIs on two counts. The holding period of the property has been reduced to 2 years from 3 years.

Now you may wonder “How does that make any difference?”

When you sell your property after 2 years, the gains would be treated as Long-term Capital Gains. Additionally, the base year for indexation would be 1 April 2001 instead of 1 April 1981.

Hence, capital gains would be taxed at the rate of 20% which is far less than 30%, and the transaction would also receive the benefit of indexation.

Let’s explore the impact with the help of an illustration.

Suppose you bought a property in 1990-91 at Rs 10 Lakh. You are planning to sell it in 2016-17 at Rs 90 lakh. You are eager to know the tax implications that Budget 2017 would have.

Also read: Tax deductions on Home loans & HRA for Self Occupied House Property

Pre-budget

Before the budgetary announcements of 2017, the base year for indexation used to be 1 April 1981. As your asset was purchased after 1981, the purchase price needs to be indexed to compute the capital gains.

Indexed cost of acquisition (ICOA) = Purchase Price * (Cost Inflation Index of Year of Sale/ Cost Inflation Index of Year of Purchase)

ICOA = 10 Lakh * 1125/182 = Rs. 61,81,319 (approx)

Capital gains = Rs 90,00,000 – Rs. 61,81,319 = Rs 28,18,681

Post-budget

As the base year has been changed to 1 April 2001, you need to compute the fair market value of your asset. It means you need to find out how much your asset is worth in 2001-02. If you assume that the property prices have increased at the rate of 10% year-on-year, then:

Fair Market Value = 10 Lakh (1+10%)^12 = Rs. 31,38,428

Now, you need to find out the indexed cost of acquisition for the financial year 2016-17:

ICOA = 31,38,428* 1125/426 = Rs. 82,88,103 (approx)

Capital gains = Rs 90,00,000 – Rs. 82,88,103 = Rs 7,11,897

By now you would have understood that this change would make a substantial difference to your overall tax liability. The shift has reduced your tax on house property considerably. However, one point needs to be emphasised here.

In this example, it is assumed that property prices would have grown by 10% every year. The rate of inflation may significantly alter your tax benefits. A low inflation rate would dent your tax benefits. On the contrary, a higher rate of inflation in property prices could hike your tax benefits.

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Final Words

With the drying up of tax incentive on the second home, it looks like you need to change your real estate plans. Especially, if you were thinking of financing such purchase out of a home loan. The interest cost incurred on home loan far outweigh the benefit of capital gains. You won’t be getting the tax benefits that you would have got before. Now house property needs to be looked upon more as a consumption asset rather than an investment asset. You might be required to explore other means to diversify your investment portfolio.

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