HUF: Can it save you taxes? Here are the pros and cons of setting one up

You may have heard that setting up a Hindu Undivided Family (HUF) could help save taxes. In this blog, we discuss this in detail. There are fairly low barriers to setting up an HUF—any Hindu (including Jain, Buddhist, and Sikhs) can do so. Only the state of Kerala has abolished the concept of the joint family system by law.

A HUF can comprise four generations of a male ancestor, but all the generations don’t need to exist to create a HUF. A family of two can also start an HUF, extending with the male ancestors. All family members, including adopted members, with a common male ancestor (i.e., daughters and sons, grandchildren, and great-grandchildren) are coparceners—and, therefore, members of the HUF. 

Marrying into a family makes a woman a member of the HUF and not a coparcener. Men do not become members of their wives’ HUF. Additionally, no one can be a member of more than one HUF except married women.

Tax Benefits of HUFs

A HUF is considered a separate legal entity. Therefore, it must file taxes separately, making it eligible for certain separate tax exemptions and deductions.

The individual income slabs apply to HUFs as well. If you opt for the new regime, the basic exemption limit is available (currently INR 3,00,000). On the other hand, if you choose an old tax regime, most deductions that apply to an individual would apply to a HUF.

Some of these deductions are – 

• Deduction of INR 1,50,000, under Section 80C of the Income Tax Act, 1961
• Donations under Section 80G
• Deduction on health insurance premiums under Section 80D, and 
• Deductions from capital gains, from the sale of residential property, under Section 54 & 54F

For example, if an individual has income from salary and property, he/she will declare it under the individual income tax returns only and claim applicable deductions and exemptions. If they have a HUF, the income from the property can be split between the individual and the HUF. Applicable deductions and exemptions can be claimed under the individual and HUF’s tax returns separately (effectively, twice the deductions allowed under the Income Tax Act). Income from salary cannot be split, as businesses won’t be willing to pay a salary to a HUF account. 

Similarly, only two can be considered self-occupied for tax purposes if a person owns multiple properties. With a HUF, if the houses are owned in the HUF’s name, those properties will not be counted for the individual’s tax purposes. 

You need a registered HUF to file income tax filings. This requires an affidavit documenting the details of the HUF or an HUF Deed. Using this, you can apply for a PAN for the HUF and open a bank account.

Ancestral property rights

An HUF can help with owning a common property as a family. This can help with deductions on capital gains—i.e., when you sell a residential property, the capital gains on the sale of such property (if it is a long-term capital asset—held for three or more years) can be tax exempt if it is used to buy/construct another residential property within two years of sale or even purchased one year before the sale. 

This also helps avoid property disputes, as all the HUF members would own the property equally. When property splitting issues arise due to death/dispute, courts generally take the call to split much faster when it’s held in an HUF’s name.

Drawbacks to this structure

1. The sale of an asset from an individual/entity to the HUF may be considered a transfer, and taxed as capital gains: A coparcener of the HUF can gift property to the HUF, which will be tax-free. However, a transfer from anyone else will be considered a transfer, and taxable at the market value of the property. 
2. If a Hindu marries a person outside the religion, and under the Special Marriage Act, 1954, the Hindu spouse retains the same rights in their HUF. However, the non-Hindu spouse cannot be a coparcener or a member of the HUF, and will not be entitled to any rights from the HUF on the demise of the Hindu spouse.
3. Customization in ownership of assets in the name of the HUF is not possible. Assets in the name of the HUF will be equally owned by all the HUF’s coparceners —customization on who can own what asset is not possible. This may become an issue when everyone has to consent to sell or lease a property. 

With these benefits and few restrictions, you can decide if setting up a HUF is worthwhile.