The 2024 Budget introduced several changes to the tax structure in India, and these could impact investments, including Non-Convertible Debentures (NCDs), REITs and physical properties.
Let's dive into a comparison of taxation between NCDs, physical real estate, and REITs (Real Estate Investment Trusts). Understanding the differences can help investors decide which investment is most tax-efficient, depending on their personal financial situation.
Taxation of NCDs vs. Physical Real Estate vs. REITs
Aspect | NCDs (Non-Convertible Debentures) | Physical Real Estate | REITs (Real Estate Investment Trusts) |
Income Type | Interest Income | Rental Income / Capital Gains | Dividend, Interest, and Capital Gains |
Taxation of Income | Interest taxed as per income slab (no specific deduction) | Rental income taxed as per slab, with standard deductions | Dividend tax-exempt (if from SPV), interest taxed per slab |
Capital Gains Tax | As per income slab
| Short-Term: Slab rates < 2 years Long-Term: 12.5% without indexation | Short-Term: 20% Long-Term: 12.5% without indexation |
Holding Period for LTCG | 12 months (listed) 24 months (unlisted) | 24 months | 12 months (listed) 24 months (unlisted) |
TDS (Tax Deducted at Source) | Yes, if interest > ₹5,000 (10% TDS) | TDS @2% on rent > ₹50k per month. TDS @1% on sale > INR 50 lakhs applies) | Yes, on interest component (10% if PAN provided) |
Indexation Benefit | No | No (for properties acquired after Apr 1, 2001) | No indexation for LTCG, flat 12.5% tax |
Tax Deductions | None | Deductions on home loan interest under Sec 24 (up to ₹2 lakh) | None on dividends; Exemption limit of INR 1.25 lakh on LTCG |
Transferability & Liquidity | Transferable (through the secondary market) | Low liquidity (physical sale takes time) | High liquidity (traded on stock exchanges) |
Taxation on Sale | As per income slab | STCG/LTCG applies, stamp duty + registration costs on transfer | STCG/LTCG applies |
Comparing Taxation Across NCDs, Real Estate, and REITs
A. Interest Income vs. Rental Income
NCDs: Interest from NCDs is fully taxable according to your income tax slab. This can lead to higher taxes for those in the 20-30% tax brackets, especially as there are no tax deductions to offset this income.
Physical Real Estate: Rental income from real estate is taxed similarly (added to total income and taxed per slab), but you benefit from deductions under Section 24:
30% of rental income is allowed as a standard deduction.
Interest on a home loan up to ₹2 lakh annually is deductible for a self-occupied property.
REITs: REIT income is a mix of dividends, interest, and rental income. Dividends from REITs are tax-free in the hands of the investor if distributed from the Special Purpose Vehicle (SPV). Interest income is taxed according to your slab, but unlike real estate, there are no deductions on REIT income.
B. Capital Gains Tax
NCDs:
Capital gains are considered as regular income and taxed as per your slab rate.
Physical Real Estate:
Short-term capital gains (if sold before 24 months) are taxed at slab rates.
Long-term capital gains (after 24 months) are taxed at 12.5% without the benefit of indexation.
However, real estate sales come with stamp duty and registration charges, adding to transaction costs.
REITs:
Short-term capital gains (holding period < 12 months) are taxed at 20%.
Long-term capital gains (holding > 12 months) are taxed at 12.5% without indexation.
C. Liquidity and Transferability
NCDs: NCDs are potentially liquid and may be sold on the secondary market before maturity, but liquidity depends on demand.
Physical Real Estate: Selling property is time-consuming, and you must consider the high transaction costs (stamp duty, registration fees, brokerage).
REITs: REITs offer the highest liquidity, being publicly traded on stock exchanges, making it easier to sell without hefty transaction costs.
When Does It Make Sense to Choose One Over the Other?
Choose NCDs If:
You seek regular income through interest payouts.
You prefer a fixed-income investment with a known maturity and interest rate.
The return on the NCD is high enough to offset the higher tax compared to REITs.
You want equity like returns from debt with the backing of a physical asset (in case of secured debt).
Choose Physical Real Estate If:
You want to generate rental income and take advantage of deductions like the 30% standard deduction and home loan interest under Section 24.
You’re looking for long-term appreciation and can afford the time and costs involved in buying/selling property.
You want to use real estate for personal use in addition to investment.
You are willing to bear the transaction costs like stamp duty, registration and maintenance.
Choose REITs If:
You want real estate exposure with higher liquidity and smaller capital requirements.
You prefer a diversified portfolio of real estate assets without the hassle of managing properties.
You’re looking for a mix of regular income (dividends, interest) and potential capital appreciation.
You’re in a lower tax bracket and can benefit from the tax-free dividends.
In Summary: Tax-Efficient Choices
High-income earners (in the 30% tax slab) may find REITs more attractive for regular income due to tax-free dividends and the relatively low 12.5% tax on LTCG.
Investors preferring a steady income stream should consider NCDs, especially if they want the asset backing of a secured NCD.
Physical real estate may be more suitable if you're looking for rental income and want to leverage deductions like the interest on home loans, but you must be prepared for low liquidity and higher upfront investment.
Each investment has its advantages and disadvantages, so the best choice* depends on your financial goals, tax bracket, and investment horizon. Above all, a high gross return on either investment may still make it more profitable than others despite of a higher tax rate.
*Please note that the applicable tax laws change from time to time and the applicability may vary based on your specific situation. The above is not meant to be a professional tax advice but only an overview of the different tax provisions. You should consult a professional tax advisor for definitive advice applicable to you.
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