Investing in Real Estate : Good/Bad ?
Ask anyone about investing and real estate is not far behind in the list of ‘good’ investments. Most people take knee jerk reactions without even thinking about the factors involved in real estate investment.
They think that making money from property is merely buying and selling and making a neat profit.
Let us consider the following:-
- Capital gains tax: As per income tax rules, if anyone sells real estate within 24 months (2 years) of buying it, the profit (difference between the purchase price and the selling price) will be added to his income for that particular year and taxed as per the tax bracket he is in. So if you come in the highest bracket (tax at 33.99%),your gains will be taxed at 33%. Therefore if you gained 10 lakhs from the sale, you will have to pay 3.3 lakhs as tax. If you come in lower tax bracket, then you will pay according to that tax rate i.e. 5, 10, 15, 20, 25, 30 % tax.
- Long term capital gains tax : Even if you sell after 3 years, you are liable to pay capital gains tax after indexing for inflation. Without getting into details, we can safely assume that 10% to 15% will be lost in taxes.
- Loan implications: If you have bought the house on a 15-20 year home loan, you are liable to claim exemption on your principal amount (up to 1 lakh per year) and interest (up to 1.5 lakh per year). But the fine print says, if you sell a house you bought on a home loan within 5 years of the financial year it was purchased in, you will have to reverse all the tax benefits you took during the 5 years. Therefore, if you availed of 10 lakhs tax exemption in the 5 years since purchasing the house, you will now have to repay all the benefits. So basically 10 lakhs will will be taxed at whatever income bracket you fall in. If you’re in the highest bracket of 33%,then 33% of 10 lakhs will have to be paid to income tax dept. If you are in the lower bracket, then 5, 10, 15, 20, 25, 30% will be taxed.
- Interest cost of home loan: If you have purchased a house through a loan, you have to pay EMI. EMI consists of the principal amount and interest. In the initial years, the interest component is maximum. Therefore it is safe to assume that you have paid 8 to 10 lakhs as interest to the bank in 2 years on a 20 year loan. This amount will reduce your gains on the property sale by the same 8-10 lakhs !! If you have availed of tax break on the interest component (up to2.5 lakh per year), your loss will come down somewhat (10 lakhs-3 lakhs) (considering 2 years).
- Prepayment cost: Since the RBI has passed directives recently to do away with prepayment penalty, this is not a factor anymore. Otherwise it could lower your profits even more as banks were charging up to 2% on the principal outstanding.
- Time and hassle: There is a very good quote about investing in real estate: “Real estate is easy to buy but the most difficult to sell.”
Sometimes the time taken to sell a property can take months if not more. During that time, you are investing your time and money in efforts to sell the flat. Time is money. And god forbid that you need money in a hurry, you can look at selling the property at a steep discount. If you factor in the brokerage charges (2%) and society transfer charges etc., you are looking at further reduced gains.
- Rental income: If you are thinking about making money from renting out your premises, keep in mind that the max rate of return on investment is 4%…and with property prices reaching the point of a bubble waiting to burst, the returns via rental income is close to 2%. Keep in mind that even if your don’t rent out your property, you will have to pay property taxes to the municipality and maintenance charges to your society.
Real Estate vs Bank Fixed Deposits
Now, put all this cost and hassle vs putting your money in a fixed deposit account where it earns an interest of 10% per annum.
Of course, you will pay tax on the interest earned, but you will pay at a rate of 10% (deducted at source).
The rest of the adjustment will have to be done by you when you file your income tax.
Plus, you are assured of the returns rather than depending on the market conditions (as real estate is) and your money is safe.
Of course, this story is for people who pay taxes. If you think that the income tax dept does not know who is selling and buying a flat, think again. The registration office has to forward details of all transactions above 35 lakhs to the Income tax dept. Every registration requires your pan number. All that an income tax officer has to do is just punch in your pan number into his computer and your entire life history will be in front of him. Expect a notice from him soon in that case.
So the next time anyone tells you to invest in real estate, remember what you read here.
It may save you hours of frustration and financial loss. Good Luck