Many successful investors have been rooting to add sustainable passive income avenues in their portfolios. The popularity and importance of passive income are rapidly growing and many retail investors are boarding the passive investment train. Along with knowing the benefits of earning passive income, one must also be aware of the tax implications of passive income. After all, nobody wants to give away their hard-earned money so easily.
Understanding taxation is important to optimize your earnings. And for that, we aim to simplify tax implications on some of the popular passive income sources. This article seeks to enlighten lawful ways to optimize your earnings by following the provisions under the Income Tax Act, 1961.
To begin with, let us dive directly into our favourite Real estate Passive Income sources!
Taxation on Real Estate Passive Income
Real Estate offers multiple streams of passive income. Long-term Rental Yield, Dividends from REITs, Interest Earnings on Real Estate Crowdfunding are the major forms of passive income sources in Real Estate. Following are the in-depth tax implications on the same.
- Long term Rental Yield
Rental Income from Let-out properties is taxed under the head of ‘Income from House Property. Incomes under this head are added to your Gross Total Income before final deductions u/chp VI. Hence, rental incomes are taxed as per slab rates.
Now, while calculating the tax on Income from House Property,
- First, the Gross Annual Value (GAV) of the rent is calculated based on provisions given in the Income Tax Act.
- From the GAV, the payment for Municipal Taxes is deducted only if it is paid by the owner.
- After the above deductions, we arrive at our Net Annual Value (NAV).
- From this NAV, a flat 30% deduction under Sec 24a is allowed to everyone irrespective of any repairs and maintenance expenses incurred on the property.
- Furthermore, if the property is leveraged, then interest payments towards the same can be claimed as deductions under Sec 24b. The maximum amount of deductions allowed is ₹2,00,000 for a Self-Occupied Property, and for a Let-Out property, complete interest deductions can be claimed.
- After the above deductions, we arrive at Income/Loss from the House Property.
The above process is followed for determining Income or loss arising from all the properties of the tax-payer. If the tax-payer has multiple self-occupied properties, then as per the provisions of the Income Tax Act, a maximum of two properties can be chosen to show as self-occupied property and the rest of them will be treated as Deemed Let-out property. The benefit of this provision is to claim the losses arising out of SOPs to set-off against Income from Let-out properties and even other heads.
- Dividends from REITs
Investing in Real Estate Investment Trusts through Mutual Funds or direct stocks, enables investors to earn passive income through dividends. Exceptionally performing REITs generate high profits. The companies have to pay out at least 90% of the profits to the shareholders in the form of dividends.
The taxability of such dividends falls under the head of Income from Other Sources. Under this head, dividend earnings from any Indian Company are subject to taxation at normal slab rates. From such income, no explicit deduction can be claimed for commission, brokerage, and so on. However, any interest expenditure incurred to earn such dividends can be claimed as a deduction of up to 20% of the total dividend income.
- Interest Income from Real Estate Crowdfunding
Real Estate Crowdfunding works as a Peer-to-peer lending in India. In such cases, the developer is liable to pay a fixed percentage of interest to the investors at regular intervals. These interests earned by the investors are taxable similar to the dividend payments.
Interest incomes arising from Real Estate Crowdfunding are taxed under Sec 56 (2) of the Income Tax Act. The income is added to the Gross Total Income before deductions and is taxed as per normal slab rates.
With the detailed overview of taxability for Real Estate Passive Income, let’s take a look at tax implications on the other sources of passive income.
Taxation on other sources of Passive Income
Most of the passive income sources like Mutual Funds, Direct Stocks, Bonds, Debentures and so on generate passive income in mainly two forms –
The taxation for Dividends and Interest Incomes fall under the head of Income from Other Sources. These incomes are taxable under Sec 56 (2) of the Income Tax Act. The incomes are added to your Total Income and taxed as per slab rates.
Along with the above taxation schemes on passive income, the Income Tax Act provides certain investments as deductions from their Gross Total Income. The payments towards such investments are usually allowed as deductions up to a certain limit.
Tax-free Investment Options
- Public Provident Fund
Public Provident Fund is a low-risk passive investment option. The investor needs to make a yearly contribution towards the scheme and can earn interest of as high as 7.1% per annum. The PPF Investment option attracts tax exemptions in all aspects. The yearly contributions of up to 1.5 Lakhs can be claimed as deductions under Sec 80C. At the same time, Interest Earnings and Maturity are exempted from tax. Thus, Public Provident Funds are a completely tax-free passive investment option
- National Pension Scheme
National Pension Scheme is a pension scheme governed by the Pension Fund Regulatory and Development Authority. It is a market-linked product and is managed by Pension Fund Managers. The contributions to NPS by employees can be claimed as a deduction under Sec 80CCD1 up to 1.5 Lakhs. Similarly, voluntary contributions by employers can also be claimed under Sec 80CCD2 and Sec 80CCD (1b). However, the maturity amount is partially taxable in NPS.
An investor, building sustainable streams of passive income, should carefully balance the investment avenues to save maximum tax along with risk diversification within the portfolio. Following is the summary of tax structures for the above discussed passive investment options.
Passive Income Tax Structures
|Long Term Rentals||Yes – Income from House Property||Sec 24
Sec 80C – Loan Principal Repayment up to 1.5 Lakhs p.a.
|REITs||Yes – Income from Other Sources||Only for Interest Expenditure incurred to earn dividends – 20% of the total dividend|
|Real Estate Crowdfunding||Yes – Income from Other Sources||Not available|
|Dividend Income||Yes – Income from Other Sources||Not available|
|Interest Income||Yes – Income from Other Sources||Not available|
|PPF Interest and Maturity||Not taxable||Sec 80C – Yearly Contributions to PPF up to 1.5 Lakhs p.a.|
|NPS||Partially Taxable on maturity||Sec 80CCD1 – Yearly Contributions to NPS up to 1.5 Lakhs p.a.Sec 80CCD1b – Additional deduction of ₹50000
Sec 80CCD2 – 10% of Salary for employer’s contribution
With the above-detailed analysis, the investors would be in the right position to assess their taxability and invest their money in suitable passive investment options. Creating a good financial plan requires time and effort and consideration of multiple factors. One important factor amongst them is Taxation. Mastering financial discipline is a must to become wealthy through passive income. And saving taxes legally is an essential part of it.
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Passive Income Taxation in India FAQ’s:
Generally, most passive income is earned through dividends and interests which are taxable under Income from Other Sources. These incomes are taxed as per normal slab rates.
No, not all passive income is tax-free. Most investors need to optimize their passive income earnings through investing in options allowing deductions and exemptions.
Yes, except for certain passive income sources, others are taxable as per the Income Tax Act 1961.
Some really good options for earning passive income in 2021 are Real estate, Direct Stocks, Mutual Funds, Gold ETFs, PPF, and so on.