Again: How We Should Curb Black Money by Cutting Tax Exemptions in Real Estate

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The fight against black money needs a serious rethink. The demonetization of 500 and 1000 rupee notes won’t help that much. If you have black money, you’ve probably converted it already, even at a discount. To others still waiting, there will be enough opportunities. From bank managers to temples to even renting Jan Dhan accounts. The money is going to be laundered. But there’s one thing where black money is just HUGE. And that is real estate.

People buy land, and register it at low rates. So a buyer at Rs. 3,000 per square foot will register for Rs. 800, and pay the remaining in cash. Why? Because the seller doesn’t want to disclose the full income (on which only 20% tax applies but still). And then, the buyer wants to pay lower stamp duty (which can be upto 7% of the transacted value). And then, people buy through quasi-deals – like a power of attorney. You give ABC a PoA. ABC pays you something upfront. When ABC sells, ABC uses the PoA to sell as if you were selling – you get the ‘white’ portion, and ABC gets all the cash portion.

Breaking this loop is very difficult because it’s so entrenched. But there’s a very good reason that real estate is so attractive – because the “legal” buyers get phenomenal tax incentives too.

Remove these tax incentives.

There are so many it’s almost difficult to count. And we’re written about it earlier:

The Tax Sop Removal

We need a multi pronged approach to lower the tax incentives for real estate. A house is just another expense item, like a car, a television or a mobile phone. You don’t get any tax incentives for those, so we should be in the same line.

There should be no “income from house property”. If you own a house, and you rent it out, it’s business income. Period. Any interest you pay is deductible – fully. But there is one major distinction. You will not be able to offset such housing interest against salary income. Currently, you can do so.

If you rent out a house, you get like 2-3% yield. But the interest you pay on a loan are 9%+. The rest is a “loss”. This would be fair – eventually, when you make more rent, you will make a profit and you can offset the loss. But it’s unfair – because such a loss can be offset even against your salary! There is no other loss in any head – business, capital loss or otherwise – that you can offset against your salary. This makes the salaried folks speculate in housing property, which is unnecessary and fuels the black economy. Remove this clause, make housing income as regular business income.

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Second, capital gains should not be exempt if invested in a property. Right now capital gains of all sorts can be exempted from tax if you invest the gains in a property in your name. Why? This is utter nonsense. Gains made from a house itself can be given some exemption if it’s the only property you own and you can prove that you live there. But no exemptions for second houses, or houses that you have collected rent from.

Third, repayment of housing loan PRINCIPAL should not be exempt from tax under section 80C. No other loan gives you such an exemption. Since you are building equity in your house and you can eventually sell it, this exemption is not useful. It lowers the cost of buying houses even for the ultra rich, and therefore, it should be entirely removed as an exemption.

(I would further argue that no investment should be tax free under section 80C at all. Just lower tax rates. )

Fourth, we shouldn’t give lower capital risk ratios to banks for funding real estate. Banks therefore lend at lower rates for housing versus, say, loans for durables. There is no point in encouraging people to borrow for real estate, and we should instead allow only ultra low cost housing (less than 10 lakh rupees) in non-metros. (Do not support any housing in metros – they are too crowded). This will change incentives for banks and they will raise loan rates for RE lending.

RE lending is one-fourth of all new lending in the past year, and that’s been a focus point of all banks. We should curtail that substantially, and allow credit to flow to really productive sectors of the economy. Real estate is mostly a storage for black money, and if there is no incentive for people to buy real estate, prices will remain low and stable, or even fall. Losing money isn’t appealing to black money holders too (why else is it black – they don’t want to lose money to tax). Therefore less money will come in to real estate, and strong scrutiny of all RE transactions will discourage speculation.

How will we know this has succeeded? When rental yields fall to levels that are “risk free” yields – which at this point would be about 6% or so. Rents won’t go up. RE prices will fall. And that, we will all agree, is a good thing.

4 COMMENTS

  1. “This makes the salaried folks speculate in housing property, which is unnecessary and fuels the black economy.”

    Really?

    “repayment of housing loan PRINCIPAL should not be exempt from tax under section 80C. No other loan gives you such an exemption. Since you are building equity in your house and you can eventually sell it, this exemption is not useful. It lowers the cost of buying houses even for the ultra rich”

    Again. Which Ultra rich guy can take this deduction? PF exhausts the limit. On top of that you claim this lowers the cost. What is being smoked?

    • If you remove the incentive, then they can speculate anyhow but it’s without the incentive, like they speculate in anything else like Gold.

      Ultra rich people don’t pay PF. Lowers the cost means that the cost of buying a house through a loan is lower than, say, buying a TV through a loan. Unnecessary – pay the same interest and principal and don’t get to claim the principal as a deduction. We shouldn’t allow asset building mechanisms as tax saving mechanisms – because it promotes one versus the other, and that’s a waste. Why should your buying a house or my buying an ELSS fund entitle us to tax benefits on the principal? Just lower tax (or increase the tax slabs) and we’ll figure out our own ways to build our assets. Or, if you provide an exemption, tax on exit – so the tax still applies, just that it will be taxed when you sell. Same with real estate.

  2. Deepak all this is fine, but think about the domino impact aka US in 2008… Banks have built up huge portfolio in the bucket loan agt property. Most property bought is typically used for such purpose only and a sudden collapse in asset prices will have a huge liquidity impact across the board.

  3. I agree with Deepak. Tax sops should be removed and the anomalies rationalized. Provide a tax incentive if at only to the first home, and only if you live in it. Everything else is a business decision.

    Removing tax sops could be done over three years instead of one, so that property prices don’t crash. the domino effect is a real possibility, but if returns on property are close to zero for the next five years, that will become the new normal, and buyers will buy only if they want to use the property, not as a store of wealth.

    Lower yields on property will lead to better utilization of real estate for productive purposes.

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