Zakat on Property & Real Estate | Musaffa Academy

eal Estate is one of the largest asset classes in the Muslim World and Zakat on Real Estate is one of the most misunderstood obligations in Islamic Personal Finance. Many real estate owners think that because they own their main residence or a rental property, they are required to pay zakat on it. At the same time, other real estate owners are told that they do not have to pay zakat at all by the mosque leaders or at the Islamic school around the corner. In Shariah, as it is in so many things in life, the answer to this question lies somewhere in between.

Most Muslim scholars agree on all four schools of thought that the decision to grant a real estate property Mukt or exempt from Zakat is based solely on one criterion and that is the purpose and usage of the home. So the criteria to ask is as follows: - Is my home an income-generating property or is it rented to tenants? - Is it a Flip property where I the future buyer am the seller? - Is it my primary residence? These are basic questions and the answer to them will determine whether I have to pay Zakat or not on my primary residence.

The Foundational Rule: Property Itself Is Not Zakatable

The crux of the matter. Many will find this extremely hard to swallow. The zakat is not levied on the structural components of the real estate. In other words the immovable asset itself is not zakatable. On the other hand, gold and cash are movable assets that are zakatable simply because they are convertible to consumable goods and/or cash.

What is Zakatable is not so much the asset but rather what the asset produces or what its value is as a commodity. Therefore when we come to immovable property such as real estate, or even a plot of land, the question we have to ask is whether it is the rent that it is producing or the fact that one has in mind to gain some profit if one were to try and sell it to another. Everything else is irrelevant.

Your Home: No Zakat Due

I have never read, heard or came across any response from any scholar to this simple question except this: That there is no zakat on the house in which you reside. So also there is no zakat on your cloth and your car. They all qualify as personal property. There is no element of trading involved in their purchase and no element of money moving from one hand to the other.

Zakat is levied on certain items of wealth that have reached a certain level. No one is able to establish the value of such items with any degree of accuracy. The most well known example of this is real estate. Some assert that it is levied according to the value of one’s home. Others maintain that the clock stands still in relation to one’s primary home. If one were to rent it out and earn an income thereby, or trade it and earn a profit thereby, then other considerations apply.

Zakat on Rental Income: What the Scholars Say

If you are the owner of an apartment, house or commercial building and are renting it out, whether it is residential or commercial, the land itself is Zakat-exempt, but the rent earned from the land is not Zakatable.

It will be considered as your cash income and therefore as part of your savings and liquid assets. So, as soon as you receive the rent and it is credited to your bank account it forms part of your wealth. Together with your savings, investments, cash and other liquid assets, your rental income will be computed for the purpose of determining the value of your total wealth at the time of your Zakat anniversary. Accordingly, if your total wealth is above the niṣāb threshold and one full ḥawl (lunar year) has also elapsed, then you have to pay 2.5% Zakat on your entire wealth including your rental income.

How Rental Income Fits Into Your Zakat Calculation

Zakat on Rental Income Calculating zakat on your rental income can be quite simple. The easiest way to calculate it is not to try to calculate zakat on rental income separately but to include the rental income when calculating your total zakatable wealth on your zakat anniversary date. This means that to calculate your total zakatable wealth you need to add together your cash (i.e. in the bank and in your savings accounts), your wealth (e.g. your shares), your gold, and the rental income of all your properties. Then you need to subtract your zakat-exempt liabilities. Add all these amounts together and you will have your total of net zakatable assets on which you pay an amount of zakat equal to 2.5% (once again providing that it is greater than niṣāb).

Income Example: Rental Property The rent you receive from your rental property is £1,500 per month. On your zakat anniversary you have £8,000 of un-paid rent due for which you will be credited towards your total savings. You have £22,000 in savings. Total wealth for zakat purposes is therefore £30,000. Your zakat therefore will be £750 (2.5% of £30,000).

The point to remember here is that when calculating zakat on rental properties, you do not calculate zakat on the value of the rental properties. The properties are just an object to earn the income not the income itself.

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What About Rental Expenses?

More recently a number of scholars have permitted the deduction of legitimate and current expenses relating to rental property before calculating the zakat due on rental income such as mortgage payments due, maintenance costs owing and agent fees due or about to fall due. Arguably the scholar has extended the principle of deducting imminently due liabilities from the assets which attract Zakat to also include the zakatable income. However this is only a Scholarly view and one would strongly advise individuals with rental income which forms a large portion of their overall wealth seek Scholarly guidance and research in relation to the deductibility of the costs relating to their rental income prior to agreeing to their level of liability.

Zakat on Investment Property Held for Sale

Wow, what an interesting ruling on this one. So, the basic premise is that you can’t buy a property and then attempt to sell it in a short amount of time in order to gain profit from it. Scholars call this type of property urūʾḍ al-tijāra or trade goods. If your intention is to buy a piece of land with the mind set that you will profit from it as a sale by holding and flipping property, then the ruling is that the land itself is subject to Zakat in addition to any profit that you make from it.

All you need to know is whether the property was bought for investment or for inhabitation. If it was bought for trading purposes, it is considered commercial inventory and should be valued at the market value for zakat purposes. Similarly, in the case of a property developer or an investor that owns a large number of properties with the intention to sell them. A property that is put in the market to gain profit is considered as a wealth which is subject to zakat.

How to Calculate Zakat on Property Held for Sale

Zakat on your business or trade inventory Shariah makes it incumbent upon individuals to give certain percentages of their savings to specified charities as a form of donation known as zakat. Zakat is incumbent on expendable wealth in forms other than cash, also known as taqasher, meaning the aspects that may be converted and hence, fall under the heading of cash even though it is tangible, the same principles which apply to other currencies apply to goods with market values or trade values. Applying zakat to Trade Inventory or business commodity There are a number of methods and therefore school of thought however it could be reduced to the following methodology; - Market value (as of Zakat anniversary date i.e not the price that you purchase or acquire the commodity, also not the historical cost which is accumulated and that is also recorded in the company books) - The calculation is based on a percentage of 2.5% (similar to currency & cash)

I bought an apartment for £180,000 with the intention of renovating it and then selling it. On my zakat anniversary date, the value of the flat was £210,000. Therefore I have to pay zakat on £210,000 at 2.5% which is £5,250.

Depreciation for Real Estate Traders In the context of the tax code, a real estate trader is a property developer, a buy-to-flip investor or simply someone who buys and sells real estate as a business.

The Critical Role of Intention

The characterization of real estate as trade inventory for accrual basis taxpayers is generally a question of the intention of the accrual basis taxpayer. Most commentators would agree that a property which was purchased with the intent of reselling it would be considered trade inventory, and therefore would be affected by the fast appreciation rules. A property purchased with the intention of leasing for years to come would not be considered to be trade inventory. Nor would a property purchased for a person's own use or to rent would be considered trade inventory if the property is sold. The character of the property as of the time it was acquired is all that will be considered by the tax authority, and the fact that a property was subsequently sold to the taxpayer as a trade inventory item will not convert the property to trade inventory as of the time it was originally purchased.

It’s relatively simple to argue that your intention for purchasing the rental property was for personal use. Even though the primary purpose of purchasing the property was for rental income, the fact that you originally purchased the property does not necessarily mean that you intended to rent it when you decide to sell it years later. In accordance with the trade-in rule, a homeowner forms intent to occupy a primary residence when they decide to rent or sell the home. If there is any debate, it’s a good idea to exercise a large amount of due diligence and seek counsel from several Halachic authorities.

Mixed-Use Properties and Partial Ownership

You now know that real estate can be broken down into several types of categories. What happens when a real estate deal doesn’t necessarily fall into those categories? Here are some scenarios to consider: Rental property/owner occupant Imagine that you purchased a condo as your primary place of residence. You rent the main floor to a tenant, and you reside in the condo on top. What type of real estate do you own? Co-owned with family Your parents along with your 2 siblings co-bought a 4 unit property. Each of you has an equal share of the property and the 4 units are rented out to 4 different tenants. What type of real estate have you and your family members purchased?

In some cases, the Tax Authority guidelines on the taxation of whole or part of the mixed-use building can be applied to each section of the building. A self-contained residential floor is to be treated as a non-residential floor for zakatable purposes. Owning the floor as other than one’s main residence shall be treated as owning real estate and not personal. Hence, any rental income generated shall be treated as cash income. In the event part of the building is held for capital appreciation and for trade, its value shall be treated as trade inventory.

For jointly owned or shared properties it is just the percentage of ownership that is relevant when working out zakat. So if you own 50% of a rental property you will only pay zakat on 50% of the rent. The same will apply if the property is invested with the intention to sell, in which case you will only need to include 50% of the current market value.

Off-Plan and Under-Construction Properties

OFF-PLAN This refers to the purchase of property for which a deposit or instalments have been paid, with the property still under construction. The cash has been locked away and the buyer has no immediate use of it, nor any possession of the final property, which may be sold, or let.

From a Shariah perspective, almost all contemporary scholars agree that payments for an off-plan property amounts to an advance or prepayment for an asset. If the intention is to re-sell, we refer to the current market value of the future ownership of the property, and work out the value of the interest together with what one could realistically collect or sell the ownership for. If the intention is to rent it out or to occupy it, we are not on solid ground and the asset has to be valued in the same manner as non-zakatable assets during the period of construction.

Off-plan investments is another thing that you should probably refer to an Islamic finance scholar for, especially in cases of large value transactions.

What About Property Held as Long-Term Wealth Preservation?

While many buy real estate with an eye to rental income and future capital gain, some investors buy real estate as a store of value as part of an inflation play or a currency play. Other than personal and trade inventory, real estate fits awkwardly into the classification schemes. It is not personal in the sense that it is consumed, yet at the same time it is not what is referred to as trade inventory (or merchandise), since by the time the seller brings the real estate to market it is no longer intended for sale.

Almost all jurists agree that non-traded property is not Zakable in itself. Therefore, if the land is not for rental and there was no intention of selling the land, it will not be Zakable for the value of the land. However, if one can prove that it is an investment portfolio (i.e. he is buying, holding and selling it in order to get profit), then a strong case can be argued and this scholar would agree that zakat on investment properties applies.

Whether or not Emperors, Magistrates, and Bishops should pay taxes on non-rent-bearing appreciation of their non-residential immovable assets is a matter of great debate, especially given the drastic consequences for failure to do so and the current state of the law. Based on current minority authority opinion in favor of taxation on the appreciation of non-residential real estate, it would appear wiser to err on the side of caution, especially when dealing with imperial officials and high ranking religious leaders.

Summary: Zakat Rules by Property Type

Putting It All Together

Zakat on property What is the purpose of the property? - Residential property is excluded - Any rental income that the property is earning will form part of your cash wealth - Investment property will be classed as trade inventory if purchased solely for the purpose of resale and taxed at 2.5% of the current market value.

Whether a piece of land is classified as immovable property or an endowment is not always an accounting issue. Rather it is an issues of intention and how the land is being used. In cases where the land falls into two of the categories mentioned above or is unsure which category the land falls into, it is best to seek advice from an expert scholar or an Islamic finance expert. Zakat is a very important part of a Muslim’s financial dealings and one should be very vigilant when it comes to immovable property. The values of lands are in the thousands, tens of thousands and in some cases hundreds of thousands of dollars.

May Allah accept your zakat and bless your wealth. — آمين

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