Earning rental income is one of the most reliable ways to generate passive income, with monthly rentals providing a steady flow of cash. However, owning property comes with several responsibilities, including following all regulations and tax requirements.

Rental income acts as a solid form of investment and also helps a person build his retirement fund. In order to maximise your income and reduce the burden of taxes, you must have a thorough understanding of the tax structure around rental income.

This blog will guide you through the essential tax laws, the calculation process and the available exemptions to help you save more.

An Overview of Taxing Rental Property Income

The rental income you receive from renting out a residential property is taxable under the Income Tax Act of 1961. The amount of taxable income is determined based on either the property’s gross annual value or the total rental income you earn. 

Before getting into how your rental income is taxed, let’s first understand the different types of income according to the Income Tax Act. For easier tax computation, income is divided into five categories:

• Income from salary

• Income from house property

• Income from profits and gains of a business or profession

• Income from capital gains

• Income from other sources

Rental income from residential properties falls under the "Income from House Property" category. 

Which Section of the Income Tax Act Covers Income from House Property?

The rules related to taxing income from house property are outlined in Section 22 of the Income Tax Act. For a property’s income to be taxed, certain conditions must be met:

1. The assessee must be the legal owner of the property.

2. The property must be either land or a building, including any land attached to the building.

3. The owner cannot use the property for their own commercial or professional activities, as the profit earned from that is taxed under a separate category.

What Are the Different Types of Rental Income?

There are various types of rental income, and each is treated slightly differently under the Income Tax Act. Here’s an overview:

1. Income from House Property

This refers to the rent earned from leasing out residential buildings, apartments, or land attached to a property. It also includes any advance payment received as a security deposit.

2. Rental Income from Partly Self-Occupied Property

If you live in part of your property and rent out the rest, the rental income from the let-out portion is taxable under the "Income from House Property" category. In this case, each part of the property is considered a separate unit and is treated independently for tax purposes.

1. Income from the rented portion: This is taxable and must be reported under rental income when filing taxes.

2. Self-occupied portion: This is the part of the property where you or your family live. It is not taxed as rental income, but it will be taxed as per the taxation rules for a self-occupied property.

Note: Before FY 2019-20, if you owned more than one self-occupied property, only one could be treated as self-occupied, and the rest were taxed as if they were rented out (Deemed Let Out Property). From FY 2019-20 onwards, you can claim two properties as self-occupied, and any additional properties will be treated as ‘rented’ for tax purposes.

3. Rental Income from Composite Rent

Composite rent refers to a situation where the rent charged includes payment for additional services or amenities beyond just the property itself. This could include furniture, appliances, or services like security and lift maintenance.

This is how composite rent is taxed:

• Rent from the building: The rent received for the property is taxed under "Income from House Property."

• Rent from other assets or services: The income from renting out assets like furniture or providing services is taxed separately. It either falls under "Income from Other Sources" or "Profits and Gains from Business or Profession," depending on the nature and scale of services provided.

For example, if you rent out a furnished apartment and charge extra for the furniture, you'll need to separate these components for tax purposes. The basic rent goes under property income, while the furniture charges might be classified as income from other sources.

Rental Income Not Taxed Under 'Income from House Property'

Not all rental-related income falls under the 'Income from House Property' category:

• Sub-letting by tenants: If a tenant rents out a portion of the property they are occupying, their income is not taxed as rental income for the property owner. 

• Inseparable rental income: In cases where renting the property and other assets, like equipment or services, cannot be separated (for instance, renting out a fully equipped theatre), the entire rent is treated differently. Since the rent covers both the building and the assets together, it will be taxed under "Income from Other Sources."

Understanding the Basis of Rental Income Tax

Tax on rental income is primarily based on the Gross Annual Value (GAV) of the property. This refers to the maximum rent the property can earn in a year if fully rented. This value forms the basis for calculating your rental income tax. 

However, you don't have to pay tax on the entire GAV, as there are several deductions that reduce the taxable amount, such as maintenance and repair costs, municipal taxes, and home loan interest.

Let’s break it down with a step-by-step guide to understand how you can calculate your rental income tax.

How is Income Tax on Rental Income Calculated in India?

Here’s how you calculate the tax on rental income:

Step 1: Calculate Expected Rent

The first step is determining the Expected Rent of your property. This is usually the higher value between the fair rental value (the rent charged for similar properties in the area) and the municipal value (as determined by local authorities). However, it cannot exceed the standard rent set under the Rent Control Act (if applicable).

Step 2: Calculate Actual Rent and Gross Annual Value (GAV)

Actual Rent refers to the rent that you are actually receiving from tenants over the year. If the property was rented out for the entire year, the Gross Annual Value (GAV) would simply be the actual rent collected.

However, suppose the property was vacant for part of the year. In that case, the GAV will be the higher amount between the expected rent (what the property could have earned if fully rented) and the actual rent received during the rented period.

Step 3: Deduct Municipal Taxes

Once you have calculated the GAV, subtract any municipal taxes (such as property tax) paid during the year to get the Net Annual Value (NAV). 

From the NAV, you can claim a standard deduction of 30% to cover expenses like maintenance and repairs, regardless of the actual amount you spent. This is allowed under Section 24A of the Income Tax Act. 

Step 4: Claim Housing Loan Interest Deductions

If you have taken a home loan to buy the property, you can claim a deduction for the interest paid on that loan. For self-occupied properties, the limit is ₹2 lakh per year, but there is no limit for let-out properties. This deduction is allowed under Section 24B of the Income Tax Act.

Note: This applies to loans for purchasing or constructing a property. However, in the case of construction, the deduction is available only after completion.

Step 5: Determine Taxable Rental Income

Finally, after subtracting all the deductions, the amount left is your Taxable Rental Income. You will need to pay taxes on this income based on your applicable tax slab rate. 

Illustrative Example

Let’s take the example of Mr Rahul, who owns a residential property that he rents out for ₹40,000 per month. Here are the details:

1. Rent: ₹40,000/per month

2. Municipal Taxes Paid: ₹30,000 annually

3. Home Loan Interest Paid: ₹1,20,000

We will now calculate Mr. Rahul's taxable rental income.

Calculation StepAmount (₹)Monthly Rent₹40,000Gross Annual Value (GAV) (₹40,000 x 12)₹4,80,000Deduct Municipal Taxes₹4,80,000 - ₹30,000 = ₹4,50,000 (Now, this is the NAV)Standard Deduction (30% of NAV)30% of ₹4,50,000 = ₹1,35,000
₹4,50,000 - ₹1,35,000 = ₹3,15,000Deduct Home Loan Interest₹3,15,000 - ₹1,20,000 = ₹1,95,000Taxable Rental Income₹1,95,000

After applying all deductions, Mr. Rahul’s Taxable Rental Income is ₹1,95,000.

Note: No tax is applicable on rental income if the Gross Annual Value (GAV) is less than ₹2.5 lakh.

How to Calculate Income from House Property?

Here’s how you can calculate income from house property:

Determine Gross Annual Value (GAV): For self-occupied properties, the GAV is zero. For a deemed let-out property, the GAV is the expected market rent.

Reduce Property Tax: First, deduct property taxes paid to arrive at the Net Annual Value (NAV).

Calculate Standard Deduction (30%): Reduce 30% on the NAV to account for maintenance and repairs, regardless of the actual expenses.

Deduct Home Loan Interest: If you have taken a home loan, the interest paid can be deducted. For self-occupied properties, the maximum deduction is ₹2 lakh, but this is only available under the old tax regime. Under the new tax regime, this deduction is not allowed for self-occupied properties.

Income or Loss: After deducting all expenses, you will determine whether there is income or loss from the property. A loss can be carried forward for up to 8 years and offset against future income from house property.

Which Type of Properties Are Not Taxable in India?

There are certain types of properties that are entirely tax-free, meaning taxpayers do not have to include the rental income from these properties while calculating their income tax. Here’s a list:

• Property used by the owner for business purposes (Section 22 of the Income Tax Act).

• Self-occupied property used as the owner’s personal residence (Section 23(2)).

• Properties located on or near agricultural land, such as farmhouses (Section 10(1)).

• House properties used for charitable or religious purposes (Section 11)

• Properties rented to local authorities (Section 10(20))

• Properties let out to approved scientific research associations (Section 10(21))

• Properties occupied by certified trade unions (Section 10(24))

• Any property owned by political parties that is rented out (Section 13A)

• Properties used by certified medical or educational institutions (Section 10(23C))

• Income from leasing a warehouse used for storing, processing, or promoting commodities (under Section 22 of the Revenue Tax Act). This applies if the warehouse is part of an organisation governed by laws related to commodity marketing.

How to Save Tax on Rental Income?

The Indian Income Tax Act offers several deductions and exemptions that can significantly reduce the taxes you pay on your rental income:

1. Standard Deduction for NAV Repairs

You can claim a flat 30% deduction on the Net Annual Value (NAV) of the property to cover costs like repairs and maintenance, even if you haven’t spent that amount. 

2. Home Loan Interest Deductions

If you have taken a home loan to purchase or construct the property, you can claim a deduction on the interest paid. 

Additionally, Section 80EEA provides an extra tax deduction of up to ₹1.5 lakh for first-time homebuyers in India. 

3. Co-Ownership Tax Benefits

Joint property ownership can help reduce rental income tax, especially if co-owners take out a home loan to fund the property.

Co-owners are eligible for tax deductions under both Section 24 (for interest on home loans) and Section 80C (for principal repayment). Here’s how it works:

• Interest deduction under Section 24: Each co-owner can claim a deduction of up to ₹2 lakh per year for interest paid on a home loan, provided they are co-borrowers.

• Principal repayment deduction under Section 80C: Co-owners can also claim deductions of up to ₹1.5 lakh each for principal repayments, as long as they are co-borrowers.

Note: The total deductions claimed by co-owners cannot exceed the actual interest and principal amount paid in a financial year. The tax benefits are divided based on the ownership percentages as outlined in the conveyance deed.

4. Unpaid or Unrealized Rent

Unpaid rent refers to the rent that the property owner could not collect from the tenant. You must meet the following conditions to claim tax exemption on unpaid rent:

• The rental agreement must be valid and legally binding.

• The landlord must prove that the tenant has defaulted on the rent.

• The landlord must prove that the tenant has either evacuated the property or that they have made efforts to remove them.

• The landlord must prove that they have tried to recover the rent, even through legal means, or should be able to show that legal action won’t work.

If the unpaid rent is recovered later, it is taxed in the year of recovery under Section 25AA of the Income Tax Act. This applies even if the property is no longer rented at that time.

Conditions for Claiming Home Loan Interest Deduction

When claiming a home loan interest deduction, certain conditions can limit the deduction amount to Rs 30,000. This happens in three main situations:

• If the home loan was taken before April 1, 1999

• If the home loan was taken on or after 1 April 1999 specifically for repairs, renovation, or renewal of your property

• If the home loan was taken on or after 1 April 1999 and the construction or purchase of the property is not completed within five years of getting the loan

Tax for NRIs on Rental Income

NRIs (Non-Resident Indians) who earn rental income from property in India are taxed on that income under Section 24 of the Income Tax Act. However, the process is slightly different for NRIs, as the tenant is responsible for making the tax payment.

Here’s how it works-

1. The tenant deducts a portion of the rent as TDS (Tax Deducted at Source) before making the payment.

2. After deducting the TDS, the tenant pays the remaining rent amount to the NRI's account. 

3. The tenant then submits the TDS to the tax authorities and files Form 15CA with the Income Tax Department, detailing the payment.

NRIs are liable to pay tax twice, i.e., once in India and again in the country where they reside. To avoid double taxation, the NRIs can check if there is a Double Taxation Avoidance Agreement (DTAA) between India and their country of residence. 

Which Section of the Income Tax Act Covers Income from House Property?

The rules for taxing income from house property are outlined in Section 22 of the Income Tax Act. For a property’s income to be taxed, certain conditions must be met:

4. The assessee must be the legal owner of the property.

5. The property must be either land or a building, including any land attached to the building.

6. The owner cannot use the property for their own commercial or professional activities, as the profit earned from that is taxed under a separate category.

Budget 2024-25 Update: New Rules for Declaring Rental Income

The Budget 2024-25 brought a change in how landlords report their rental income. Previously, some landlords reported rental income under the 'Profits and Gains from Business and Profession' category.

As per the new rule, all rental income from residential properties must be reported under the 'Income from House Property' category.

Conclusion

When it comes to earning secure and passive income through renting your properties, understanding the tax implications can greatly influence your overall strategy. By adopting the right approach, you can maximise returns, reduce expenses, and ensure your rental properties remain a reliable long-term income source.

 However, it is always advisable to consult a tax professional or lawyer for case-specific advice. Also, rent calculations and tax regulations discussed in the blog are based on current central government guidelines, which are subject to change. So, always stay updated with the latest tax laws and guidelines.

Frequently Asked Questions: FAQs

What is the GST on Rental Income?

Rental income from residential properties is exempt from GST. However, rental income from commercial properties is subject to 18% GST.

Is rental income considered earned income in India?

As per current tax laws in India, rental income is not considered as earned income. It is classified as passive income because it comes from your personal property, not from active work. 

What are the consequences of not paying rental Income Tax?

Individuals who fail to pay taxes on their rental income may face penalty interest rates ranging from 1-2% on the outstanding amount. The exact percentage can vary depending on where your property is located. Furthermore, if they disregard a show cause notice, the municipality can initiate legal actions to recover the outstanding amount. This recovery process can involve freezing funds in bank accounts, claiming rental payments, or seizing movable assets.

What is the income tax treatment of arrears of rent?

Arrears of rent are taxable in the year you receive them. You must include this income even if you didn’t own the property when you received it. You can deduct 30% of the arrears before calculating your tax. Under Section 23(1), the income is assessed, and Section 25(A) allows adjustments for unpaid rent. 

How should rental income from a shop Space be taxed?

For rental income to be taxed under "Income from House Property," the rented property must be either a building or land associated with it. Since a shop qualifies as a building, any rental income from that shop should be reported under the "Income from House Property" category.

What type of rental Property is the most profitable in India?

Residential properties are great for steady income and long-term growth, but commercial properties usually offer higher returns because they often have long-term leases with built-in rent increases. It's important to do some market research to see which type of property will give you the best returns based on your location and budget.

How is tax imposed on vacant houses in India?

If you own more than two houses, you can choose two as Self-Occupied Properties, even if they are vacant, and they won't be taxed. However, any additional vacant houses are treated as Deemed Let Out Properties, and the notional rent is taxed as income under "Income from House Property."

 What is a good Return on investment (ROI) for rental property in India?

A good return on investment for rental property in India typically ranges between 3% and 4.6%.