House rent: Landlords may save tax using this method

A furnished house commands higher rental than an unfurnished one, however, do keep in mind that a higher income also comes with higher tax liability. To save income tax, a landlord might be inclined to charge his/her tenants rent separately for the unfurnished house and for the furnishings that he/she has provided. However, does this help in saving income tax?

ET Wealth Online tells you when this may work and when it may not.

Furnished houses are preferred by many tenants who do not want to go through the hassle of moving from one rental house to another with a big list of household items. They are willing to pay higher rent for a furnished house. Furnishing can be any goods or services that the tenant requires to stay inside the flat. Some examples of furnishings include heater, washing machine, air conditioner, cooler, fan, iron, clothes drying rack, bedside table, tea table, sofa, dining table, bed, almirah, utility storage, shoe rack, mattress, water purifier, geyser, cleaning and maintenance services, light bulb or LED, exhaust fan, chimney, etc.

For a tax-paying landlord, in the case of two separate rent agreements (one for the unfurnished house and one for the furnishings), it is important to know that certain tax deductions will not be available.

Here’s how it is taxed

From an income tax perspective, all types of incomes have been divided into different categories. “A landlord can show his rental income as income from rent of house property if he has separately created two rent agreements- rent for house space and rent for furnishings. If the two rents are not separately shown then the landlord cannot show such rental income as income from rent of house property,” says Prabhakar K S, founder and CEO, Shree Tax Chambers, a Bengaluru-based tax firm.

In case of a single agreement, the landlord will be required to distinguish between house rent and furnishing rent. Experts say that the rental amount collected for furnishings is to be classified either as business income or income from other sources, depending upon the nature of the transaction.

According to Prabhakar, “The portion of the rent attributable to the housing space shall come under income from house property. The portion of rent for furnishing should either be classified either as business income or income from other sources.”

For example, a landlord may charge Rs 30,000 per month as rent for the house and Rs 10,000 per month as rent for the bed, mattress, sofa, TV, dining table, geyser, washing machine, AC and water purifier.

Income tax deductions that landlords can claim

Since there are two types of incomes — rent for space in the house and rent for furnishings — the tax deductions must accordingly be claimed based on the type of income.

Deductions for income from rent of space in house

If the rent of the unfurnished house is classified as income from house property, then the landlord can claim certain deductions- standard deduction under section 24, municipal taxes paid and interest on house loan from the gross annual value of the house.

“No other deduction for any expense is allowed apart from these,” says chartered accountant Manas Chugh, head, regulatory services, Osgan Consultants, a tax and business consultancy firm.

Also read: How to calculate income from house property.

Deductions for income from rent for furnishing

The income from letting out furnishings in a house can either be classified as business income or income from other sources.

When you classify it as business income

If an income is classified as business income, then expenses that are incurred to facilitate the income, can be claimed as a deduction. Further, depreciation on the house property can also be claimed as a tax deduction.

When you classify it as income from other sources

If a landlord is classifying the rental income from furnishings as income from other sources, then only expenses directly relating to such an income can be claimed as a deduction. “Expenses incidental to earning such an income cannot be claimed as a deduction. Direct connection of the expenses with that income is a must for the said expense to be claimed as a deduction from income. Like repair expenses on furniture is a direct expense,” says Chugh.

What is more beneficial for the landlord?

“It depends on the landlord’s facts and circumstances when it comes to the characterisation of such income under the head business/house property/other sources. In the case of a house property, there is a standard deduction of 30% allowable on the net annual value perpetually; under business income, the expenses and depreciation can be claimed as a deduction from the income. In the case of other sources, only certain direct expenses can be claimed as deduction. One may to evaluate the facts and tax cost associated with it.,” says chartered accountant Prasanna K, partner, M2K advisors, a business and tax consulting firm.

While business income gives more options for deductions, it has its preconditions. If a landlord wants to show the income as a business income, then he has to prove that he is running a business of renting out house furnishings.

A case for masking of house rent as reimbursement for expenses

There could be a situation where a landlord could charge an amount of money in the name of reimbursement for expenses from his/her tenant. For example: a landlord takes reimbursement from his/her tenant for expenses incurred on cleaning and washing the floors and bathrooms. Another instance can be when the landlord is taking reimbursement from his/her tenant for electricity expenses paid by him/her on the tenant’s behalf.

“The reimbursement for the expenses incurred on behalf of the tenant will only be allowed to the extent it is actually incurred. Any amount received over and above the amount actually incurred for the expenses will be taxable as income from other sources,” says Chugh.

If the landlord of the furnished house is also getting reimbursement for certain expenses, then it needs to be mentioned in the rent agreement. “It would be preferable to enter into two separate agreements, one rent agreement for the house property and the second rent agreement for the furnishings and services. The landlord must also insert the reimbursement clause in the rental agreement to avoid any dispute,” says Chugh.

William Murphy

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