How to get MORE out of your HRA

If you are a salaried professional and living in a rented house, then you must be aware of the HRA component of your salary. HRA is house rent allowance paid by company to meet your rent expenses and this amount is tax deductible (tax free) up to some extent. This tax-free amount is calculated on the basis of three rules defined by the Income tax department.

Normally, most of us have this understanding that whatever HRA amount we receive as part of our salary is the maximum amount that is considered for tax rebate.

For example, if you are receiving Rs 5,000 per month as HRA, then while calculating the HRA tax rebate, only Rs 5,000 will be considered even if you pay more rent. This is NOT correct.

Click NEXT to get the details.

Courtesy: Am22tech.com 

The three income tax rules for calculating tax rebate on HRA:

The exemption is capped to the LEAST of following three values:

1. Actual HRA received during the financial year.
2. 50% of BASIC salary in case of residential accommodation taken on rent is situated in a METRO city (Only Mumbai, Kolkata, Delhi or Chennai) and 40% of BASIC salary in Non-metro cities.
3. Rent paid in excess of 10% of BASIC salary. That is, excess Of rent = rent paid minus 10% of Basic

HRA amount that is part of your salary package is actually defined by your basic salary in most cases. That is, it is normally 40% or 50% of your basic salary. So, if your basic salary is Rs 10,000 per month, then your HRA component would be either Rs 4,000 or Rs 5,000.

The 40% or 50% factor is dependent on your company policies. The income tax rules also base their tax rebate calculation on the basic salary amount as you can see in rule 2 and 3 above.

HRA received = Rent is NOT equal to MAXIMUM tax rebate. How?

Let us consider the example below:

Now if you are declaring rent of Rs 5,000 per month considering that you are declaring more than your HRA amount, that is, Rs 5,000 would not make any difference, then you are wrong. Quickly running through the three rules would make things clear here.

Hence, if you see carefully, you are only eligible for Rs 48,000 tax rebate even though your yearly HRA and rent paid and declared amount is Rs 60,000. Income tax officials have designed the rules so cleverly that you will always end up getting the least tax rebate if you look at the HRA component alone.

It is simple mathematics if you just look at the rules and do some calculation.

The rules are primarily based on basic salary, HRA amount and rent paid/declared. You can't change basic salary and HRA component. But you can certainly change your rent paid amount. So, the hack is that if you pay a rent figure which brings the amount in all three rules equivalent to the maximum of three, you would be eligible for maximum tax rebate.

Here is an example that will clarify the concept better. We are just increasing the rent paid amount to Rs 6,000 keeping basic and HRA same as in above example and re-calculate the HRA as per the three rules:

So, if you look at the least amount now, it is Rs 60,000 which is equal to the maximum of three values too.

How to find this optimum value of rent for maximum tax benefit?

Hmm..As I said it is a simple mathematical formula. If you want to do it on your own, here are the steps you should follow:

1. Find the maximum value by applying Rule 1 and Rule 2. Let's call this value 'Optimum'
2. Now use this mathematical formula to find the Rent (yearly):
3. ((10 * Optimum) + Yearly Basic Salary / 10) = Yearly Rent
4. This will give you the value of yearly rent that will give you the maximum tax rebate. Divide this amount by 12 to reach the figure for your monthly rent.

That's it. You are the winner now.