
Buying homes: Why tax policies need a tweak
Summary
- Current terms encourage speculation in real estate, which doesn’t work well for those looking to buy homes to live in
Mumbai: India’s income tax system is built in favour of the non-salaried rich. One facet of this is income tax laws encouraging investment in real estate. Many investors buy residential homes and then keep them locked. They drive up home prices and a few end up cornering a good chunk of the residential real estate market. They also make renting difficult. And this is not environmentally friendly as well.
Given these reasons, income tax laws that incentivize investing in real estate need to be rewritten. The agenda can perhaps be set with the interim budget which is due on 1 February and then moved further once the budget for 2024-25 is presented in July after the Lok Sabha elections. In this piece, we will look at why this needs to be done and what exactly the government can do.
Home loans
Take a look at the chart. It plots two curves. The ratio of priority home loans given by banks to overall home loans and the ratio of non-priority home loans given by banks to overall home loans.
Now, before we analyse the chart, it’s important to state a few things. First, priority sector home loans are defined as: “Loans to individuals up to ₹35 lakh in metropolitan centres (with a population of 1 million and above) and up to ₹25 lakh in other centres… provided the overall cost of the dwelling unit in the metropolitan centre and at other centres does not exceed ₹45 lakh and ₹30 lakh, respectively." The remaining home loans are non-priority home loans.
Second, home loans in India are given by commercial banks and housing finance companies. As per the National Housing Bank’s Report on Trend and Progress of Housing in India 2022, as of March 2022, of the total outstanding home loans of ₹25.11 trillion, 68% were distributed by banks and the remaining 32% by housing finance companies. As of 1 July 2023, HDFC, the largest home finance company, merged with HDFC Bank. With this merger, the share of banks in the total home loans distributed crossed more than 80%. Given this, the home loans given by banks are now an even better representation of the home loan market in India, than was the case in the past.
The chart considers loans given by HDFC as a part of the banking system starting from July 2023. In November 2023, the ratio of priority home loans to overall home loans stood at 28.5%, and that of non-priority loans stood at 71.5%. (If we leave out HDFC loans, the ratio of priority home loans and non-priority home loans to overall home loans was at a very similar 29.5% and 70.5%, respectively.) What the chart clearly tells us is that the ratio of priority home loans has been falling over the years and that of non-priority home loans has been rising.
Now, what does this mean? This basically means that more home loans are being used to finance the buying of more expensive homes. In fact, the percentages don’t reveal the gravity of the problem over the last few years.
Over the last three years, the total increase in outstanding home loans given by banks (without taking HDFC’s loans into account), has stood at ₹7.7 trillion. Of this, more than 87% are non-priority loans. Over a period of five years, close to four-fifths of the incremental outstanding home loans are non-priority.
Clearly, banks have been funding higher-priced homes of people who are in a position to pay higher EMIs. People investing in homes and indulging in conspicuous consumption (particularly non-resident Indians)—that is rich individuals buying homes to show off their wealth—and keeping them locked, add to demand and push up home prices, in the process making things difficult for those who want to buy homes to live in.
The environment

Different materials go into building a home, everything from steel, bricks, sand, concrete, ceramics, plastics, glass and even a lot of water. Production of these materials requires the burning of fossil fuels. Vaclav Smil explains this in detail in How the World Really Works, where he points out that concrete, plastics and steel are the three of the four pillars on which human civilization is built (the fourth being ammonia). As he writes:
“The mass scale production of all of them depends heavily on the combustion of fossil fuels." He further points out: “Iron ore smelting in blast furnaces requires coke made from coal (and also natural gas); energy for cement production comes mostly from coal dust, petroleum coke, and heavy fuel oil." Cement is “the indispensable component of concrete". Iron ore is used to make steel. And all of this leads to the emission of greenhouse gases. Also, construction leads to the generation of dust, which adds to pollution. Take the case of Mumbai. As a report by research firm Liases Foras points out: “The annual incremental construction in the BMC [Brihanmumbai Municipal Corporation] limit of Mumbai has grown 68% since 2022 and 142% from 2021. The Mumbai Metropolitan Region (MMR) also shows a 36% growth since FY22 and 98% growth since FY21."
Now, after all this, if a new home is bought and locked up, what’s the point? It leads to the emission of greenhouse gases, which possibly wouldn’t have emitted otherwise. It generates construction dust. It leads to the usage of a lot of water, which isn’t exactly available in abundance to start with. It leads to the digging up of more sand than is required, and given that a good portion of sand mining isn’t exactly organized, it leads to an increase in illegal sand mining.
Affordable housing
Raghuram Rajan and Rohit Lamba talk about Rajan’s experience as the Reserve Bank of India (RBI) governor in Breaking the Mould—Reimagining India’s Economic Future: “When Raghu served as governor of the RBI, one of his most enjoyable experiences was the annual party for the RBI drivers, cooks and waiters and their families at his home. These workers proudly introduced their children—one a software engineer, the other an officer working for a multinational bank. These families had made the jump from lower middle class to upper middle class in one generation, in part because the RBI had employed someone in the family in a low paying but steady job with decent housing and health-care benefits."
The point being that the availability of decent affordable housing in cities plays a huge role in uplifting a family economically. But affordable housing in India isn’t going anywhere. A recent news report on livemint.com quoted Ravi Subramanian, the managing director and chief executive officer of Shriram Housing Finance Ltd, as saying: “The government should raise the cap on the affordable housing segment…Now, the upper limit or ceiling is ₹45 lakh, which is quite inadequate."
₹45 lakh in a country with an expected per capita income of ₹2.13 lakh in 2023-24, is a lot of money.
Also, as data from Stats of India, based on the World Inequality Database, points out, 90% of Indians make less than ₹25,000 per month. Of course, the situation in cities might just be a tad better than the overall scenario.
So, even at ₹45 lakh per pop, the so-called affordable housing is a luxury in India. This is clearly visible in the home-loan data shared above, where a bulk of the loans given out in recent years have been non-priority ones. In this scenario, if investors and the conspicuous consumers continue buying homes, it only makes the situation worse.
Tax policy


Tax policy in India incentivizes buying homes as an investment. Income earned from the salary or business income of an individual is taxed at the marginal rate of tax. The highest marginal rate of tax, even without taking the different kinds of surcharges for higher income into account, is 30%. At the same time, long-term capital gains made from selling residential real estate is taxed at 20% with indexation benefits being available. Indexation allows the consideration of inflation while calculating the price of buying a house as well as improvements made on it over the years, in order to calculate capital gains. Long-term capital gains on selling a home come into the picture if the period of holding between the buy date and the sell date is more than 24 months. This effectively means that the tax on capital gains (a form of income) made from buying and selling of homes, is significantly less than even 20% (it can be even lower than 10%). Plus, the holding period of two years is way too low.
This is something that the coming interim budget and the full budget need to take a look into. The current terms encourage speculation in real estate, which doesn’t work well for those looking to buy homes to live in. The government should consider taxing capital gains arising from the sale of homes at the marginal rate of tax, like it now does in the case of debt mutual funds and like it has always done in the case of interest earned on the humble fixed deposit.
Also, this does not hurt those looking to upgrade their house, given that capital gains are exempt from income tax, if they are used to buy a new home or two new homes, to the extent that the investment is made one year before the sale or within two years of the sale. Also, this option can be exercised by the taxpayer only once in their lifetime provided the amount of long-term capital gain does not exceed ₹2 crore.
Of course, moving towards a simpler tax regime will lead to loud protests from those who benefit from this (read the non-salaried rich and chartered accountants). As Jonathan Haskel and Stian Westlake write in Restarting the Future—How to Fix the Intangible Economy: “Small groups have a particular advantage when the matter at stake is not obvious, as in the case of income tax rates and income tax exemptions. Income tax rates, which are usually progressive, take a larger percentage of rich people’s income, but income tax exemptions are typically much more generous for richer groups."
At the same time, the government needs to encourage those who own homes, to not keep them locked and rent them out. On the tax front, this can be achieved by taxing rental income from homes at a lower tax rate. This will also discourage those landlords who insist that tenants pay them in cash (at least in part).
Of course, this will only be a very small step in making residential real estate in cities across India a little more affordable, given that the sector is too complicated and too convoluted to be set right only through incentives and tax policy.
Real estate index

The government also needs to come up with a proper real estate index that the country currently lacks. The RBI’s House Price Index is released once every three months. As of now, the latest data available is for September 2023. Further, the coverage of the index is limited to just 10 cities. It doesn’t cover large cities like Hyderabad, Pune, Surat, etc. Also, there is no detailed breakup available for individual cities, at least not in the public domain.
It is important that a monthly index is developed. This will be very helpful given that people won’t just depend on hearsay while deciding to invest in real estate, but will have access to real data. Also, the calculators which allow people to calculate the real returns they earn on investing in real estate need to be developed. Currently, most individuals calculate real estate returns by subtracting one large number, the price at which they had bought, from another large number, the price at which they had sold. They fail to take into account several important factors like the time value of money, the interest paid on the home loan, the property tax paid over the years and the maintenance charges paid to the society. This leads to the mistaken belief that real estate always delivers fantastic returns, which many people who invested from 2011 to 2021, found out wasn’t the case.
Vivek Kaul is the author of Bad Money.