Tax Treatment of Rental Income from House Property Held as Stock-in-Trade: Section 23(5)

 

Explained

Imagine this: you’re a real estate developer. You’ve just finished building a shiny new apartment project. You’ve put up banners, listed it online, and even had a few potential buyers visit. But despite all your efforts, some flats remain unsold.

Now you’re stuck with a question that many builders face: “What if I rent these flats out for the time being? How will the taxman treat this income?”

That’s where Section 23(5) of the Income Tax Act steps in.

 

Why Was Section 23(5) Introduced?

Earlier, developers used to keep unsold flats vacant for years and declare zero income on them, claiming “they’re just stock, not investments.” The government wasn’t too happy with this, because it meant no tax was being paid on properties that clearly had rental potential.

So in 2017, the Finance Act introduced Section 23(5), a rule specially crafted for builders and developers.

 

What Does Section 23(5) Actually Say?

Here’s the rule in simple words:

• After you get a completion certificate for your project, you get a 2-year grace period.
• During these 2 years, the annual value of your unsold flats will be considered Nil → meaning no tax on notional rent.
• But once 2 years are over, if you still haven’t sold those flats, the taxman assumes you could rent them and earn income. So from the 3rd year onwards, you’ll have to pay tax on the notional rent (fair rental value), even if the flats are lying vacant.

Think of it as the government saying: “We’ll give you two years to sell your stock. But if you can’t, we’ll treat it as if you’re earning rent from it.”

 

Example:

Say you completed a housing project in March 2024, and you still have 8 unsold flats.

• From FY 2024-25 and FY 2025-26 → No tax on notional rent (relax, you’re safe 😅).
• From FY 2026-27 onwards → Whether you sell or not, the notional rental value will be taxed under Income from House Property.

If you actually rent out any flat before that, of course, the actual rent will be taxed.

 

But Wait… Business Income or House Property Income?

Here’s the twist many people don’t expect. Even though flats are your stock-in-trade (business asset), the law clearly says:

• Sale of flats = Business Income.
• Rent from flats = Income from House Property (not business).

So yes, even for developers, rental income is always considered House Property Income.

 

Deductions You Can Claim

When the notional rent (or actual rent) is taxed under House Property:

• ✅ 30% standard deduction under Section 24(a).
• ✅ Municipal taxes paid.
• ❌ No deduction for your business-related costs (like salaries, marketing, etc.) against rental income.

 

Why Does This Matter for Builders?

Many developers feel this is unfair, because they already face challenges selling flats in a slow market. On top of that, paying tax on income they haven’t even earned (notional rent) feels like rubbing salt in the wound.

But from the government’s perspective, it discourages builders from hoarding property and forces quicker sales.

 

Key Takeaways

• Section 23(5) applies to unsold flats held as stock-in-trade.
• 2 years grace after completion = no notional rent tax.
• From year 3 onwards, notional rent is taxable under House Property.
• Deductions allowed = 30% standard deduction + municipal taxes.
• Rental income ≠ Business Income, even for developers.

 

Human Angle – What You Should Do

If you’re a builder or an LLP/partnership in real estate, here’s the bottom line:

👉 Don’t think of unsold flats as “free holding.” After 2 years, they start eating into your profits through notional rent taxation.
👉 If sales are slow, consider renting them out early—at least the rent you earn will help offset some tax.
👉 Plan your cash flow keeping Section 23(5) in mind.

Because at the end of the day, one unsold flat isn’t just locked-up capital—it’s also a future tax burden.