Tax Implications of Rental Income: 'Income from House Property' vs 'Business Profits'

Classification of rental income as Income from House Property or Business Income is a grey area in the Income Tax Act. While it is more beneficial to classify rental income as business income, various factors like ownership of the property, purpose and nature of the activity needs to be considered to determine whether the income is house property income or business income. 

A plethora of deductions can be claimed against rental income classified as business income, whereas deduction is restricted to standard deduction, municipal taxes and interest on home loan for house property income. This article explains in detail, the situations in which income is classified whether it is rental or business income, the consequences along with illustrations.

Rental Income as Income from House Property

Where the primary purpose of owning the property, whether residential or commercial, is to rent it out, the rental income is classified as ‘Income from House Property’.

Taxation Framework:

• The rental income is taxed based on the Gross Annual Value (GAV), which is the higher of the actual rent received or the fair market rent of the property. 
• You can claim certain deductions to reduce the taxable income. 
• The following are the deductions available:
  • Municipal Taxes: Taxes paid to local authorities can be deducted from GAV to calculate the Net Annual Value (NAV).
  • Standard Deduction: A 30% standard deduction on NAV is allowed to cover repairs, maintenance, and other associated costs.
  • Home Loan Interest: If the property is financed through a home loan, the interest paid can be deducted under Section 24(b).
• If rental income is the assessee’s only source of income, then the total income will be exempt from tax as long as it remains within the Basic Exemption Limit — which is ₹3 lakh under the new regime and ₹2.5 lakh under the old regime for FY 2024-25.
• If the assessee has other income than the aforesaid income, the total income, after reducing all deductions and exemptions, is considered for reckoning basic exemption limit.  

Example: If a property generates a rent of ₹35,000 per month, municipal taxes paid are Rs. 20,000, and the home loan interest paid is Rs. 60,000. Calculate the taxable rental income.

Rental Income as ‘Business Income’

In some cases, rental income may be classified as 'Business Profits', primarily when the property is leased as part of a business. It usually applies where the main business of the taxpayer is renting out the properties. 

Taxation Framework:

• A wider range of deductions is available under business income, including expenses related to property management, repairs, utilities, and staff salaries, etc.,
• Many of the deductions are not available under the 'Income from House Property' category.
• The income from this business, after reducing all other deductions is not taxable as long as it does not exceed the basic exemption limit. The Basic Exemption limit is the same here as well, Rs. 3 lakhs for new regime and RS. 2.5 lakhs for old regime - FY 2024-25
• In short, the tax slabs for rental income classified as busines income and rental income are one and the same. 

Supreme Court Rulings of Certain Case Laws

The Supreme Court cases Chennai Properties and Investments Ltd. v. CIT (2015), Rayala Corporation (P) Ltd. v. Asstt. CIT (2016), and Raj Dadarkar and Associates v. ACIT (2017) address the classification of income from property leasing for taxation. These rulings have clarified that when property leasing is a main business activity, the income should be considered "business income" rather than just rental income. The judgments stress the importance of looking at what the taxpayer is actually doing with the property, rather than simply focusing on ownership, to determine how the income should be taxed. 

Conclusion

Understanding whether rental income is classified as "Income from House Property" or "Business Profits" is vital for proper tax filing and optimization. Rental income is generally taxed as "House Property" unless the property is part of a business operation, in which case it is considered "Business Income." The Supreme Court rulings emphasize evaluating the taxpayer's activities, not just property ownership, to ensure fair and accurate tax treatment.