Income from rental property has different connotations depending on whether it is treated as house property or business income
- Rental income from a property could be treated as income from House Property and income from Business and Profession
- If the property income is declared as business income then the owner can claim a tax deduction on actual expenses
- Property income is considered as income from house property if the property is not used by the owner for business or professional purpose
It is common to come across several retired people who have properties that they let out from which they earn income that meets their retirement income needs. In their case the tax that they would pay on this inflow of money by way of rents will depend on how this income is treated. For most people rental income from a residential property that is let out will be treated as income from house property. But, for those who are in the business to let out property, the same rental income will be treated as business income.
There are multiple court and income tax rulings in this regard, and if you are in the business of letting out a property then the rental income even from the residential property will be considered as a business income. It is not wrong to have such an income stream and in fact, there are tax benefits to avail if one slots such income as business income instead of house property. It will help to know that in case of classification of property, income is a bit subjective. Property income can be classified as either or combination of following three: Business Income, Income from other sources or Income from house property.
Does rental income have to be reported to IRS?
Rental Income IRS
The classification depends on the line of the business of the owner. Taxability of income from renting of immovable properties (Land and Buildings) can broadly fall under the following two heads of income in the Income Tax Act: Income from House Property (HP) and Income from Business and Profession (PGBP).
The taxability as house property provides (or limits) a standard deduction of 30% of the income along with a deduction on interest paid on borrowed capital for the purposes of acquisition, construction, repair, reconstruction, etc. (subject to limitations provided under the Act). However, in cases when the taxation is under PGBP, any expenditure mentioned or expended wholly and exclusively for the business of leasing shall be allowed as a deduction for tax purposes.
As there are no limits or restrictions on deductions under the head PGBP, taxpayers veer towards classifying rental income received from lease of immovable property as PGBP. Obviously, this requires the support of facts in every case. The tax authorities, on the other hand, argue that rental income should be chargeable to tax as HP Income, perhaps the ease (and limitation) of deductions under HP being the driving force.
This gives rise to a situation where taxpayers and the department can confront each other on the manner in which the property is being considered for the purpose of taxation. But there have been several instances of conflict, which has also resulted in the judiciary stepping in to analyse and clarify the stand on how to treat rental income under the head PGBP.
The intent of taxpayer can be gathered from the agreement for lease, Memorandum of Association and subsequent conduct of the parties. So, in case of active ownership of property; if the property yields rental income by virtue of its own legal existence it would be classified as passive ownership and may be classified as HP. The trend of recent judicial precedents and directions released by the Central Board of Direct Taxes (CBDT) reveal that the authorities are now accepting that ownership of property and leasing it out may also be done as part of a “business,” apart from as a mere owner.
According to the tax authorities the deciding factor is not the ownership of the land or leases, but the nature of the activity of the taxpayer and the nature of the operations in relation to the same. Further, the Apex court has emphasised that for income to be characterised as “business income,” the activities actually carried out by the taxpayer need to be in line with its main object, according to its constitution documents.
As recently as April 2017, the CBDT issued a circular, wherein it has been clarified that the income from letting out of premises or developed space along with other facilities in an industrial park or SEZ is to be charged to tax under the head PGBP and has guided the department in not filing any appeals on this issue and to withdraw or not press upon appeals already filed.
As owner of property, you should know that residential and commercial properties are treated in the same way from a tax perspective. The core of this entire discussion is the main line of business of owner irrespective the property is residential or commercial. With this clarity, you could slot the income that you receive from letting out a property can be classified to avail tax benefits.
