16 September, 2010

Are you buying a property to save taxes ?

Saving tax is a pet preoccupation with our citizenry. Sometimes it borders on the ridiculous. People will go to any extent to save taxes. While saving taxes is a legitimate exercise, one needs to evaluate whether it makes sense to make certain investments, primarily to save tax.
Investments by definition is something that needs to give a reasonable return, after taxes. Also, investments have other aspects which need to be considered like tenure, liquidity, risk potential, returns, suitability for meeting goal requirements etc. Tax efficiency is but one such aspect.
Due to the rapid property value rise in the past five years, many have assumed that it will continue it’s upward rise, uninterrupted. It won’t. Also, it will not be able to rise at a compounded 20%, like it has risen in the past few years. It’s most likely to settle at a sedate single digit long-term growth rate of maybe 7-8%. Massive increases in property prices have stalled the markets and transactions have come down. It has to come down, pause a bit for income to catch up and move. So, in light of this, we need to evaluate whether investing in a property for primarily saving taxes is a great idea.
Property is bought for residential use and as an investment. If it is for use as one’s home, then tax considerations recede into the background… for one will anyway go in for it, for personal consumption. Tax concessions over and above that, is icing on the cake. Let us examine what are the tax concessions for a self occupied property.
For a self-occupied property ( where the whole or part is not let out & no benefit is derived from it ), the maximum interest permissible to be set off would be Rs.1.5 Lakhs. This is subject to the condition that the capital is borrowed on or after April 1, 1999. The deduction is Rs.30,000/- pa for capital borrowed towards acquiring home property before April 1, 1999. Also, the acquisition / construction should be completed within 3 years from the end of the Financial Year in which capital was borrowed. The loan agency needs to certify in respect of the interest payable against the loan taken for acquisition of house property. So, in case a person is taking a loan of Rs.50 Lakhs and the interest in the first year comes to Rs.5 Lakhs, he could avail a deduction of only Rs.1.5 Lakhs. The tax saved at the highest bracket is Rs.46,350/- assuming that the borrower is in the highest tax slab. Hence, if tax saving is the preeminent consideration, it is going to be met, only to a small extent. In this situation, an EMI of in the region of Rs.50,000/-pm would also be added on and has to be carried on for years – maybe two decades!
Again people have the view that it is still a good idea as an asset gets created. Most again have the view that when one starts paying an EMI, the surplus cash that one has gets used up and the chances of frittering away any surpluses comes down. While this is true, it also creates a long-term liability. This creates a problem in case of any income disruption. Especially in a situation when the loan taken requires two people to work ( which today, is mostly the case ), it snatches away the possibility of one person stopping work. If the husband and wife are working, and they have a small child at home, both of them have to continue working even if the lady wants to stay back to take care of the child. This is being played out across the country today.
Also, people are very mobile and their careers can take them to various cities or even abroad, over time. If they have invested in one city say Mumbai and they get transferred to say Delhi, they will have to put the house in Mumbai on rent and rent out another in Delhi. This again is happening in a lot many cases, in view of the increased mobility and churn. This beats the very purpose of buying the home in the first place. Also, the argument that in future the homes will become so costly as to be unaffordable is also untenable. As it is, even today the prices in many suburban areas is unaffordable for most middle class households. Assuming a long-term increase of 7-8% in property, it can clearly be bought at a later point when one has dropped anchor. Till such time, it may be a good idea to stay in rented properties, which typically are available at reasonable prices ( typically the annual rental is about 3-4% of the value of the property ). This gives one the flexibility and freedom to pursue opportunities unhindered.
In summary, buying a residential property for residential purposes makes sense if,
1. One is clear that this is the city in which they want to settle.
2. They are getting the property at a fair value.
3. They are clear that they can shoulder the responsibility of repaying the loans for an extended period of time.

Published in Business Standard on 12/09/2010

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