NOTIONAL RENT AND TAX IMPLICATIONS

NOTIONAL RENT AND TAX IMPLICATIONS FOR REAL ESTATE DEVELOPERS

KEY INSIGHTS FOR VALUATION PROFESSIONALS

By Er. Sundeep Bansal, Council of Engineers and Valuers (CEV) Legal & Valuation Desk

Introduction

The concept of notional rent—also known as deemed rental income—has significant tax implications for property owners, including real estate developers, in India. While the general principle of notional rent applies to self-occupied and vacant properties, its implications for unsold flats held by developers have been subject to changing regulations over the years. As we navigate the taxation landscape for the financial year 2024-25 and beyond, it is crucial for valuation professionals to understand how these provisions affect the real estate sector, particularly for unsold inventory in completed projects.

In this article, we provide a detailed analysis of the current tax provisions related to notional rent, the taxation of unsold flats held by real estate developers, and how these developments influence the work of valuation professionals.

What is Notional Rent?

In simple terms, notional rent refers to the rental income that is assumed to be earned from a property, even if it is not actually let out. Under the Income Tax Act, notional rent is taxable in certain circumstances, particularly when a property is vacant or deemed to generate income even without an actual lease agreement.

Calculation of Notional Rent

Notional rent is calculated based on the concept of Gross Annual Value (GAV) and Net Annual Value (NAV). Below is the step-by-step process to determine notional rent under the current Income Tax Act for the assessment year 2025-26.

Gross Annual Value (GAV):
- For a property that is let out, GAV is the higher of:
  - Expected Rent (ER), which is the higher of Municipal Value (MV) or Fair Rent (FR), but cannot exceed Standard Rent (SR) if the property is subject to rent control laws.
  - Actual Rent Received/Receivable during the year.
- For deemed let-out properties, such as those that are not actually rented out, the GAV is the Expected Rent.
Expected Rent (ER):
ER is calculated as the higher of the Municipal Value (MV) or Fair Rent (FR). However, it cannot exceed the Standard Rent (SR), which is the maximum rent allowed under Rent Control Acts. Therefore, the formula becomes:
Net Annual Value (NAV):
NAV is derived by subtracting the municipal taxes paid by the property owner from the GAV.
Deductions (Section 24):
- Standard Deduction: 30% of NAV.
- Interest on Home Loan: For let-out properties, the interest on home loan is fully deductible. For self-occupied properties, a maximum of ₹2 lakh is allowed for interest.
Taxable Income:
The resulting income is taxable under the head “Income from House Property.”

Change in Law for Unoccupied Residential Properties (FY 2025-26 Onwards)

A significant change introduced by the Finance Bill 2025 is the abolition of the notional rent rule for unoccupied residential properties. Under this new provision, starting from FY 2025-26, property owners will no longer be required to pay tax on notional rent for residential properties that remain unoccupied, irrespective of how many properties they own.

This change brings relief to property owners with multiple residential properties, as they no longer need to account for notional rent on vacant units. However, the new provision does not apply to commercial properties, for which the original rules continue to apply.

Implications for Real Estate Developers:

Real estate developers, particularly those holding unsold inventory in completed projects, should take note of the following:

Taxation of Unsold Flats Held by Developers

A specific provision in the Income Tax Act has a significant impact on how unsold flats are taxed in India. According to Section 23(5) introduced in the Finance Act, 2017, unsold flats held as stock-in-trade by real estate developers become subject to notional rent taxation after one year from the completion of the project, irrespective of whether they are rented out or not.

Key Provisions under Section 23(5):

Stock-in-Trade: For developers, any completed property held as stock-in-trade is deemed to be let out after one year from the end of the financial year in which the completion certificate is issued.
Taxable Income: Once the property is deemed to be let out, the developer is required to declare notional rental income under the head “Income from House Property,” which is taxable.
Deduction for Developer: Developers can claim a 30% standard deduction on the notional rent under Section 24(a) of the Income Tax Act.
Timing of Taxation: For example, if a completion certificate is received in March 2022, the notional rent becomes taxable starting April 2023 (Assessment Year 2024-25).

Example for Developers:

Let’s consider a developer who has completed a housing project and holds 5 unsold flats. The completion certificate was issued in March 2022. For the financial year 2023-24, the notional rental income becomes taxable as follows:

Completion Certificate Date: March 2022
Date when Notional Rent Taxable: April 2023 (FY 2023-24)
Deemed Rental Income (Annual Lettable Value or ALV): This will be calculated based on expected rent (similar to the process for self-occupied or vacant properties).
Taxable Income: The developer must declare the deemed rent as part of their income from house property for tax purposes.
Deductions: The developer can claim a 30% standard deduction on the deemed rental income, reducing the taxable amount.

Implications for Valuation Professionals

For valuation professionals, these provisions carry several practical implications, especially when it comes to determining the value of unsold flats in completed projects and advising clients on potential tax liabilities.

Valuation of Unsold Inventory: Valuation professionals will need to ensure that the value of unsold flats is accurately determined, as these flats will now be subject to notional rent taxation. The rental potential of these flats may impact their value, particularly if the developer holds them for a long period.
Advisory Role: With the abolition of notional rent for unoccupied residential properties (from FY 2025-26), valuation professionals must keep clients updated on changes in tax laws. For developers with unsold flats, it will be important to factor in the impact of Section 23(5) in financial planning and tax projections.
Impact on Capitalization Rates: For developers holding unsold inventory, the introduction of notional rent taxation may influence their decision-making regarding pricing, sale strategies, and holding periods. Valuation professionals may need to adjust capitalization rates to account for the additional tax liability.

Key Takeaways

The concept of notional rent has evolved significantly over the years, and it remains a critical issue for real estate developers, particularly those with unsold flats in completed projects. With the introduction of Section 23(5) in 2017 and the abolition of notional rent for unoccupied residential properties starting from FY 2025-26, the landscape has shifted, requiring developers and valuation professionals to adapt to the changing taxation environment.

As professionals in the field, it is imperative to stay abreast of these changes, as they not only affect tax liabilities but also the broader financial strategies of real estate developers. By understanding the nuances of notional rent taxation, valuation professionals can provide valuable advice to their clients, helping them navigate the complex world of real estate taxation with greater precision.

This article has been prepared for the CEV Group’s newspaper to inform valuation professionals of the recent changes in tax provisions related to notional rent and unsold flats held by developers. Understanding these provisions will help ensure accurate valuation and sound financial decision-making in an evolving regulatory environment.