House rent allowance is a popular head of allowance in your salary structure. This allowance not only compensates for the rental expenses but can also help you save tax.
Like anything else, knowing your tax possibilities with HRA will help you maximise your tax savings.
How to Calculate HRA Exemption?
Rule 2A of the Income Tax Act guides the HRA exemption estimates. As per this rule, the least of the following will be exempt:
a) Actual HRA your employer has paid youb) 50% of Salary if you are living in Delhi, Mumbai, Kolkata or Chennai, 40% of Salary for other citiesc) Actual rent paid over 10% of Salary
Salary = Basic salary + Dearness allowance + Commission based on % of turnover
For example, if you are working in the Delhi area and have the following salary structure in FY 2020-21:
|DA (also part of retirement deductions)||10,000|
And you have paid a steady rent of Rs 25,000 p.m., your HRA estimate will be as follows:
- Total HRA received in FY 2020-21: Rs 3 Lakhs
- 50% of Salary (Basic + DA + Commission as fixed % of turnover): Rs 3.6 Lakhs
- Rent Paid over 10% of Salary: Rs 2.28 Lakhs (3 Lakhs – 50% of 7.2 Lakhs)
Since the lowest of the three amounts is Rs 2.28 Lakhs, this is the exempt amount. And, the remaining HRA, which is Rs 72,000, will be added to your taxable income for the FY.
If you are estimating your HRA benefit, take care of changes in the salary and monthly rent you have paid. You will need to estimate HRA exemption separately for the periods with:
- Different HRA amounts
- Different amounts of rent paid
For example, if you changed your employment with a new salary package in September 2020. You will need to estimate HRA exemption separately for:
- April 2020 to August 2020
- September 2020 to March 2021
Similarly, if you start paying a different amount of rent from January 2021, you will estimate HRA exemptions for the periods:
- April 2020 to December 2020
- January 2021 to March 2021
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HRA Exemption When you Own a House
It is common nowadays to buy a house with a home loan and then start residing on rent for ease of work commute. In such situations, you may have a question about the exemptions you can claim. That is:
- HRA exemption for the rent paid
- Exemption on the home loan interest paid
The answer is that you can claim both HRA and exemption under sections 24B and 80C for home loan payments. However, you will need to take care of the following:
- You are staying in a different city and paying rent
- You have reasonable cause to stay on the rent if residing in the same city as your house property
Tax Exemption When you do not Receive HRA
If HRA is not part of your salary but you have been paying rent, you can claim deduction under section 80GG. This is also a method of relief for the rent payments if you are self-employed.
Thus, use 80GG to improve your tax savings for the rent paid if:
1. You are a salaried employee or self-employed
2. You have not received HRA for a period in the previous year (your 80GG claim will be limited to this period only)
3. There is no house property in yours, your spouse or your minor child’s name at the current place of residence
Section 80GG allows you to claim an exemption equal to the least of the following three:
a) Rs 5000 per monthb) 25% of total income after adjusting for capital gains and deductions except for 80GGc) Rent paid over 10% of the salary (only within the period for which HRA was not received)
HRA Exemption When you are Staying with your Parents
You can claim HRA exemption while staying with your parents, provided:
- You are paying rent to them
- They are showing the rent as their income from house property in their ITRs
Thus, although this transaction is possible, both ITRs could be necessary to claim the deductions without notice.
Additional Tax Saving Investments
While HRA is a good allowance to help you save tax. But the fact is, you are spending a lot of money to save a small sum in taxes. In other words, despite the tax savings, you are not building any assets for your future.
Thus, using tax-saving investments will not only build future assets for you, but you can also continue to save tax. Following investments can help you reduce your taxable income by up to Rs 4 lakhs:
a) Buy a house property with a home loan (make sure to invest in a ready to move house for best results)i. Deduction of up to Rs 2 lakhs on interest paidii. Deduction of up to Rs 1.5 lakhs on principal repayment
b) Invest in NPS for retirement (up to 1.5 lakhs + up to Rs 50,000 more on additional self contribution)
c) Invest in Unit Linked Insurance Plans, Public Provident Funds, Sukanya Sammriddhi Yojana and Equity Linked Savings Schemes
d) Use Guaranteed Savings Plans for very important family financial goals
While you are investing in these instruments, also ensure the long-term financial safety of your family with term life insurance. With HRA and other tax-saving investments, you can reduce your tax outflow to near zero if you have an income below Rs 10 lakhs.