Rajeev Lal, 29, works as general manager with computer company LeadComp in Pune. In January 2005, he bought a second house in the city for Rs 17.5 lakh (Rs 1.75 million). He is a prime example of India's urban affluent, who are buying second houses as their incomes are rising and banks are pushing home loans at reasonable rates. Plus, the real estate boom is giving them numerous options on the kind of house to go for and where to buy it.

Level the cash flows

But buying a second house is just the beginning of the story. Once bought, a property creates its own stream of financial outflows. For most apartments, one would at least have to pay municipal taxes as well as a maintenance fee for common areas and services, like cleaners and power back-up, provided by the housing society. If the property has been bought with a loan, there would be principal repayments and interest payments.

Unless you are planning to stay in it, it is likely that you are looking at investing in property in expectation that its value will appreciate over a period of time. So, while the big inflow may happen at the end of your investment horizon, there should be current inflows to at least partially ease the burden of current outflows. That is where renting it out comes in.

Loan repayment: The rent can take care of a large chunk of the installments you would be paying if you have bought the property with a loan. In fact, that is exactly what Lal has done. "The rent is Rs 12,500 a month, which takes care of my EMI of Rs 14,000 to a large extent," he says. The security deposit can be invested and the income from it can help cover the gap between the EMI and the rent, unless the tenant defaults on rent payments.

Why you should rent

To lighten the outflow load: Of loan repayment Of municipal taxes Of society maintenance charges Of internal upkeep of the house To save on taxes: Since you will have to pay tax on a 'notional' rent from the house even if you leave it vacant. Since the entire amount paid as interest is deductible from income Since the entire amount spent on maintenance is deducted from income Since a negative net income from the house can be offset against total income

Maintenance charges: Society maintenance charges vary from one to the other. Most of the time, however, the tenant would be taking care of the maintenance charges as he would be using the facilities.

Cost of the internal maintenance of the house would depend on how much care a tenant takes of the property. On an average, one per cent of the house value can be set aside for this. While Lal, for instance, decided to put in the security deposit money in a mutual fund, other owners might like to keep that amount of cash handy in case they need to repair any damage. Even when a destructive tenant leaves the house in shambles, a forfeited deposit can help get it back in shape.

Bottom line, renting it out can make a second house pay for itself - almost.

Tackle the taxman

Letting out a property not only helps level the cash inflows and outflows, it makes sense from the taxation angle, too.

Income tax: The income tax department does not treat your second house as a self-occupied one, even if you use it or leave it vacant. The taxman will assume it is 'let out' property, that is, you are earning rent from it. "The tax department requires that you pay tax on the notional rent, that is, the annual rental value," says Harsh Roongta, CEO, Apnaloan.com. It has been specifically provided in the Income Tax Act that you will be taxed on the higher of the actual rent received or notional value.

The glitch is, the methodology for deciding the notional rent varies from state to state. However, it is usually fixed depending on the municipal value of the property and the annual rental value of similar properties in the area. For instance, in Safdarjung Enclave area of south Delhi, the notional rent of a 1,350 sq. ft apartment would be around Rs 12,000 per month.

One advantage of a second house is that, unlike a self-occupied house, the entire amount paid as interest on a home loan, even if it is more than Rs 150,000, can be deducted from the pre-tax income.

Also, the amount spent on repairing and maintaining the second house is allowed as deduction from the income. So, you will finally pay taxes on the net income from the second house, which is annual rent (higher of actual and notional) reduced by municipal taxes, standard deduction (30 per cent of annual rent net of municipal taxes) and interest on home loan.

In the example above, let us assume that the property has been left vacant by the owner, who pays income tax in the highest slab. If he has not borrowed to buy the house, he may end up paying around Rs 30,000 a year (after adjusting for municipal tax and deduction) as tax on income that he does not earn.

If, however, the net income is negative, it can be set off against income from other such property. The remaining loss, if any, can be set off against any other income.

Wealth Tax: One residential property in your name is exempted from wealth tax. However, if you own two houses in your name, you would have to pay wealth tax. Says Roongta: "When you own two houses, you may also have to pay wealth tax if the value of the house that has been treated as not self-occupied, net of the loan taken for it, along with other assets chargeable to wealth tax exceeds Rs 15 lakh (Rs 1.5 million)." The wealth tax is one per cent of the net wealth, exceeding Rs 15 lakh.

"It is prudent to rent out as gains are immense," advises Rajiv Bajaj, managing director, Bajaj Capital. "That's the only way he can derive maximum benefit out of this investment strategy," he asserts.

Do the due diligence

While the case for renting out your second house is strong, make such a move only after you are sure about the people you are renting it out to. Make direct contact with your would-be tenant. Even if a property broker is involved, personal contact will let you understand the person.

"Any rent agreement which is for a period of more than 11 months needs to be registered" for it to have any legal validity, says Delhi-based legal expert Kamal Agnihotri. For that, the agreement has to be done on stamp paper. Always consult a lawyer before getting into an agreement.

Whether you are renting out to a company or an individual, verify the credentials of the tenant, especially when the house is not close to the place where you stay. According to Rishi Awasthi, a Delhi-based lawyer: "It is advisable to lease out to companies as they normally do not voluntarily violate the terms of contract."

So, if you have decided that real estate is what you like investing in, rent it out for an efficient portfolio.