Notional rent is the rent that you are assumed to have earned under the Income Tax Act, 1961 even if you don’t actually earn any rent on a property. The provision was introduced to discourage taxpayers from leaving houses vacant and create supply of properties for tenants.
As of now, you can claim one house you own as self-occupied, but need to pay notional rent on the second house even if it is self-occupied. The interim budget 2019 increased the number of houses you can claim as self-occupied to two. If you own more than two houses, you can claim any two of them as self-occupied and you do not have to pay tax on notional rent for them.
However, you will still have to pay notional rent on the second house for FY2018-19, as the interim budget proposals will be effective from FY2019-20.
Notional rent is assumed based on the annual value of the property. This is the value at which the property may be reasonably expected to let out year after year. It is calculated using the concepts of fair rent, municipal value and standard rent. You are allowed to deduct municipal taxes from annual rental value while calculating notional rent.
Fair rent is the rent that a similar property can fetch in the same or similar locality, while municipal value is the rental value as determined by the relevant municipal authority. Standard rent is fixed under an applicable Rent Control Act; where such a law applies, the landlord cannot charge a higher rent than what the law permits.
Here’s how the calculation works. For instance, if the annual fair rent of an apartment is ₹2.40 lakh, the municipal value is ₹1.80 lakh, and the standard rent is ₹3 lakh. To calculate the expected rent, take the higher of the fair rent and municipal value. In this case, the fair rent of ₹2.40 lakh is the higher of the two. Compare this figure with the standard rent, and take the lower of the two; in this case, the fair rent is lower. The fair rent of ₹2.40 lakh is then the expected rent of the property. The next step is to deduct municipal tax, say ₹20,000, from the expected rent to arrive at the net annual value, which comes to ₹2.20 lakh.
Tax you pay
You get a standard deduction of 30% when calculating the tax you pay on notional rent under Section 24 of the Income Tax Act. This deduction is on account of expenses you have incurred for the maintenance of the property.
In the example above, 30% of ₹2.20 lakh or ₹66,000 will be deducted. This will reduce your annual taxable rent to ₹1.54 lakh.
However, if you have a home loan on the property, any interest paid on the same will be eligible for tax deduction. So the taxable amount will come down further.
Note that the net amount after the deduction/s is considered as “income/loss from house property" and taxed at your income tax slab rate. However, the amount of loss from house property that you can set off against other income is limited to ₹2 lakh.
So, in the above example, if you have paid an interest of ₹5 lakh on home loan against the property, your loss would be ₹3.46 lakh, but only ₹2 lakh can be set off; the remaining ₹1.46 lakh can be carried forward for the next eight assessment years.
But if your tax slab is 20% and you don’t have a home loan, you will be liable to pay tax of ₹32,032 (20% tax and 4% health and education cess) on an annual rental value of ₹1.54 lakh after the 30% deduction.