One thing that Jaitley can do to control speculation in real estate

India-Real-Estate-MarketIn response to yesterday’s column I got an interesting email from a reader. The email has prompted me to write another column on real estate.
Talking about the budget presented by the Narendra Modi government in July 2014, the reader said: “
The most detrimental thing that the government did was hike the deduction limit from Rs 1.5 lakh to Rs 2 lakh!!!”
The finance minister Arun Jaitley had said
in his budget speech: “Housing continues to be an area of concern for middle and lower middle class due to high cost of financing. Therefore, to reduce this burden, I propose to increase the deduction limit on account of interest on [home] loan in respect of self occupied house property from Rs 1.5 lakh to Rs 2 lakh.”
This should not have been done the reader suggested, as it leads to more speculation in real estate. As he wrote in his email: “ Even in Vasai or Virar or any other distant suburb from where people come to Mumbai to work, flats are not cheap.” What makes the situation worse is the fact that “people with high incomes living in Mumbai invest in such distant suburbs to avail tax benefits and capital appreciation.”
What the reader was basically saying is that individuals who already own flats and are living a comfortable life in Mumbai, buy “cheaper” flats in suburbs to avail tax benefits. I am sure something similar must be happening in other cities as well.
At the same time such individuals hope to make capital gains from the purchase in the years to come, as real estate prices keep going up. With more money chasing the same number of flats, prices go up. This makes flats more expensive for people who want to buy and live in them.
While the reader has got the speculation bit right, he has got the tax part of it wrong. It doesn’t make any sense for an individual to buy a flat for the sake of investment, so that he can get a deduction of Rs 2 lakh on it and save Rs 61,800 in the process (assuming he comes in the top tax bracket and pays a total tax of 30.9%).
The amount is too small to be taking on the headache of owning a flat in a distant suburb. Further, chances are that the individual would be already repaying a home loan for the flat that he lives in. Hence, he can’t take the same deduction for two flats.
Nevertheless, it would still make sense for an individual looking to buy a flat(and this need not be limited to just one flat) for investment purposes to go ahead and save money in the process.
In fact, the Income Tax Act actually encourages people to speculate in real estate.
There is no restriction on the number of homes against which a tax payer can claim a tax deduction on the interest paid on the home loan to fund the property. Only one of these properties needs to categorized as a self-occupied property. On this self-occupied property, an interest of up to Rs 2 lakh can be claimed as a tax deduction.
This limit applies only to the self-occupied property and not on other homes that a tax payer may choose to buy. Any amount of interest paid on home loans can be claimed as a deduction as long as a “notional rent” is added to the income. We all know that these days “rents” are relatively low in comparison to the EMIs that need to be paid in order to repay the home loan.
Hence, the interest component tends to be massive during the initial years and helps people with two or more homes, claim huge tax deductions. This was the point that the reader who sent in an email was trying to make, even though he got the tax deduction part wrong.
This “deduction” has been used over the years by well paid corporate employees to bring down their taxable income. Further, individuals who use this deduction benefit on two fronts—tax deduction as well as capital appreciation. Even if, the capital appreciation is not huge, such individuals are happy in claiming just the deduction than actually making money from an increase in price. Hence, they may not sell the flat, even in a scenario where prices may be falling.
While offering a tax deduction on a self occupied property makes some sense, there is no logic to offering a tax deduction on a home, one is not living in. This “deduction” needs to be plugged immediately as it encourages speculation.

Arun Jaitley has an opportunity to do a huge favour to the people of this country by removing this deduction in the forthcoming budget. Whether he goes around to do that will only become clear once the budget is presented on February 28, later this month.

Postscript: I had written in a column last week that I would be surprised if the economic growth for this financial year would be greater than 7%, as per the new method of calculating the GDP. Data released yesterday by the ministry of statistics and programme implementation suggests that the Indian economy is likely to grow by 7.4% during this financial year. Turns out I was wrong in writing what I did.
As per the old method of calculating the GDP the economic growth during this financial year was supposed to be at 5.5%. No reasonable explanation has been offered for this jump in growth. At the same time other high frequency data like bank loan growth, corporate profitability, stalled projects, massive slowdown in collection of tax revenues etc., seems to suggest that the economic growth should be more around 5.5% than 7.4%.
I will keep track of this and in the days to come will try and come up with a possible explanation for this huge difference in the two numbers.

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Feb 10, 2015

Advertisements

About vivekkaul
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System , the latest book in the trilogy has just been published. The first two books in the trilogy were published in November 2013 and July 2014 respectively. Both the books were bestsellers on Amazon.com and Amazon.in. Currently he works as an economic commentator and writes regular columns for www.firstpost.com. He is also the India editor of The Daily Reckoning newsletter published by www.equitymaster.com. His writing has appeared across various other publications in India. These include The Times of India, Business Standard,Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal, Quartz.com, DailyO.in, Business World, Huffington Post and Wealth Insight. In the past he has also been a regular columnist for www.rediff.com. He has lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore). He has also taught a course titled Indian Economy to the PGPMX batch of IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He can be reached at vivek.kaul@gmail.com

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: