Today multiple investment options are available in the market and one of them is real estate. When asking anyone about investing in real estate most people including financial experts give instant responses that real estate is a good investment option.

Everyone thinks that one can earn lacs of rupees by buying and selling real estate and it provides decent returns. Yes, real estate does provide good returns after a few years or months of investment. However, apart from a return, you have to consider various other factors before deciding whether real estate investment is a good or bad investment option. In this post, I will guide you to decide whether real estate is a good investment option or bad.

Real Estate Investment – Good or Bad?

Thinking of real estate as a good investment option my friend purchased a 2 BHK flat at a prime location in Navi Mumbai in 2010 for investment purposes. After 1 year that flat was giving him a return of 15% and to fetch a profit he sold this flat.

Unfortunately, he was unaware of the capital gain tax on selling property. He ended up paying a substantial amount as tax on the profit. He also had to shell out the tax exemptions that he was availing of on the home loan. After considering this tax implication he was earning a 7% return only. 

Learning – Financial transactions without knowledge can turn into disasters. 

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Let’s understand all factors described above, before making any real estate investments –

Real Estate Investment Implications 

Short-term Capital Gain 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 30%), your gains will be taxed at 30%. Therefore if you gained 10 lakhs from the sale, you will have to pay 3 lakhs as tax.

Long-term Capital Gain Tax

As per tax rules if you sell real estate after three years or 24 months, then it’s considered long-term capital gain (LTCG) and you have to pay 20% of the profit as tax with indexation.

You can get an exemption from this tax under certain conditions. “To get the exemption, you need to purchase the new residential house within a period of one year prior to or two years after the transfer of the original house. As far as the under-construction house goes, the construction needs to be completed within three years from the date of transfer of the original house.”

If the cost of the new residential property exceeds the capital gains, then all capital gains are exempted from taxes.

Loan implications

Due to lack of money if you have bought the house by taking a home loan then you can take advantage of tax exemption on your principal amount (up to 1 lakh per year) and interest (up to 1.5 lakh per year).

The Income Tax Act says, that if you sell a house within five years of buying it, the tax benefits on the principal repayment on the home loan are reversed. These are then included in your taxable income in the year of sale.

Therefore, if you have availed 5 lakh tax exemptions for the principal (in 80 C) in the last 5 years (since the purchase of this house), you have to add this entire amount to your taxable income & you will be taxed at whatever income bracket you fall in. If you’re in the highest bracket of 30%, then 30% of 5 lakhs will have to be paid to the income tax dept.

There is no provision for levying income tax on tax benefits claimed for home loan interest. Therefore, any tax advantage you have claimed under Section 24(b) for interest will not be subject to tax at this time.

Maintenance & Other Cost 

If you have purchased a flat then you are liable to pay a fixed maintenance cost to society every month. Not only that every year you will be paying municipality/ property tax.

RBI has passed a directive that a prepayment penalty is not applicable otherwise it could lower your profits even more as banks were charging up to a 2% penalty.

Rental Income

Many people think that they will rent their real estate investment and earn money. Nothing is wrong but the maximum rent in most of cases is around 6% of the investment amount. This 6% return will not even cover inflation.

Apart from this, you have to declare this rental income as taxable income which may increase your income tax burden.

Cost of Time and Trouble 

It is very easy to buy property but sometimes it is very difficult to sell. You might have to wait months or years together to get a good deal for your property, During that time, you are investing your time and money in efforts to sell this property.

Sometimes in need of urgent money, you may sell this property at a discounted rate or may end up paying brokerage charges to broker. This will further reduce your profit.

So, real estate is a good investment option only if:-

(1)   You can hold property for a long time (more than 3-5 Years)

(2)   If you have excessive cash you need not take any loan for making an investment.

(3)   You are making a profit in black transactions and the white transaction profit is much less.

(4)   You are always reinvesting profit from real estate to real estate.

After reading this article if you are thinking of hiding your transaction for not paying tax then think again, every transaction done above a certain value is in the eye of income tax.

Every registry paper requires your PAN card and Aadhaar Card details and these details are captured by income tax. The income tax department may send you notice & you may be in other trouble.

So next time you get advice that real estate is a good investment option do remember what you read here. It may save you time and money.

Happy Investing!