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Unrealized rent is the rent not paid by the tenant in your property in a particular financial year. In other words, the rent is due, but, the tenant has not paid the rent for any reason.
For tax purposes, it is possible to deduct unrealized rent from your rent received, and thereby avoid paying tax on such unrealized income.
Example 1: You have put one of your properties on rent, and your rent received is ₹10,000 per month or ₹120,000 per year. You are liable to pay tax on this income. However, let's say, your tenant was going through a financial crisis and was not able to pay you rent for three months. In such a scenario, you can deduct ₹30,000 (₹10,000 x 3) from the rental income, and you need to pay tax only the ₹90,000 which you have actually received.
To be able to deduct unrealized rent from your rental income, there are four conditions.
You should have enough proof to show the tenant was staying in your property. The proof can be in the form of a written agreement, and rent receipts issued, etc.
You have removed the defaulting tenant from the property because of non-payment of rent. Moreover, if he is not ready to vacate, you have taken adequate legal steps on your part to make sure he vacates the property.
The defaulting tenant should not be living in another property of the same owner. This condition is to avoid any informal arrangement between the owner and the tenant to save taxes.
The final condition is that as an owner, you have taken enough legal steps to recover the unrealized rent from the tenant. Alternatively, if legal steps have not been taken, the owner should convince the income tax official that there is no point in taking any legal steps. For example, the tenant has gone entirely bankrupt, and plus he has a lot of other debts, so any legal proceedings will be a waste of time.
As long as these four conditions are realized, you can deduct unrealized rent from rent received for tax purposes.
Note that if you get unrealized rent in the future, you will have to add it to your income and pay tax on this rent.
Example 2: You have unrealized rent of ₹40,000 in a particular financial year, which you have deducted from your rent received, and thus not paid any income tax on this amount. However, if you can recover this amount next year, you will have to add this amount to your taxable income.
To summarize, you do not have to pay tax on unrealized rent as long as you meet certain conditions. Use our tax calculator Indian Income Tax Calculator to determine how unrealized rent affects your tax payable.