Budget 2026: Will HRA Limits Be Revised Amid Soaring Rental Costs?

With Budget 2026 on the corner expectations are once again on rise among salaried taxpayers for meaningful relief amid escalating living expenses. One of the most discussed components in this context is House Rent Allowance (HRA), a tax exemption intended to ease the burden of rental housing for employees.

Rental costs across Indian cities have increased sharply in recent years. Professionals relocating back to office hubs post-pandemic, coupled with limited new housing supply, have pushed rents to levels that far outpace salary growth. Yet, HRA exemption limits have been removed from the new regime. This has made HRA into focus ahead of Budget 2026.

Legal Framework Governing HRA

The tax treatment of House Rent Allowance is governed by Section 10(13A) of the Income Tax Act, 1961, read with Rule 2A of the Income-tax Rules, 1962. Accordingly, the HRA exemption available to a salaried employee is the least of the following three amounts:

• Actual HRA received from the employer
• Rent paid minus 10% of salary
• 40% of salary for non-metro cities or 50% of salary for metro cities

For this purpose, salary includes:

• Basic salary
• Dearness allowance (to the extent it forms part of retirement benefits)

Example: Consider an employee living in Kochi (non-metro for HRA purposes):

• Basic salary: ₹60,000 per month
• HRA received: ₹30,000 per month
• Rent paid: ₹35,000 per month

Annual figures:

• Salary: ₹7,20,000
• HRA received: ₹3,60,000
• Rent paid: ₹4,20,000

Exemption calculation:

• Actual HRA received: ₹3,60,000
• Rent paid minus 10% of salary: ₹4,20,000 − ₹72,000 = ₹3,48,000
• 40% of salary: ₹2,88,000

Exempt HRA = ₹2,88,000 (lowest of the three)

Despite paying ₹4.2 lakh in rent, a significant portion remains taxable, this constraint is imposed by the fixed percentage ceiling.

Why HRA Limits Are Being Questioned

Post-COVID, rental markets especially in metro cities have seen steep increases. Employees returning to physical offices have intensified demand in business districts, while rising property prices have translated into higher rents. However, the 40% / 50% salary cap has not been revised for decades. As a result:

• Employees paying high rents often hit the ceiling quickly
• Actual rent paid bears little relevance once the salary percentage threshold is crossed

An employee in Mumbai earning ₹15 lakh annually may pay ₹60,000 per month in rent. Even with high rent:

• The 50% of salary limit caps exemption
• Any rent beyond that ceiling offers no additional tax benefit

Impact of Stagnant HRA Limits on Salaried Taxpayers

The stagnation of HRA limits has consequences:

• Higher effective tax outgo despite rising housing expenses
• Middle-income earners face the greatest strain, as housing consumes a large share of income
• Many employees continue with the old tax regime primarily to retain HRA benefits

Consider an employee with an annual salary of ₹10 lakh, living in a large employment hub and paying monthly rent of ₹30,000. Assume the employee’s salary structure includes: i. Basic salary: ₹5 lakh per year and ii. House Rent Allowance (HRA): ₹4 lakh per year The HRA exemption is the least of the following three amounts:

1. Actual HRA received: ₹4,00,000
2. Rent paid minus 10% of salary: ₹3,60,000 − ₹50,000 = ₹3,10,000
3. 40% of salary (non-metro city): 40% of ₹5,00,000 = ₹2,00,000

Thus, eligible HRA exemption amounts to ₹2,00,000. Now since, the total annual rent paid is ₹3,60,000 and HRA exemption allowed is ₹2,00,000. Therefore, the rent effectively receiving no tax relief is ₹1,60,000. Even though the employee spends over one-third of their income on rent, nearly 45% of that expense is ignored for tax purposes due to the fixed percentage ceiling.

The Old vs New Tax Regime Debate

Currently, the HRA exemption is available only under the old tax regime and the new tax regime under Section 115BAC does not allow HRA exemption. While the new regime offers lower slab rates and simplicity, many salaried individuals still prefer the old regime solely because of HRA.

Understand this with an example, an employee with high rent and moderate deductions otherwise, may find that HRA alone tilts the balance in favour of the old regime. However, if HRA continues to lose relevance due to stagnant limits, such taxpayers may gradually shift to the new regime despite higher housing costs.

Demand for Reform

Experts propose several reforms within the existing legal structure:

• Revision of the 40% / 50% salary ceiling to reflect modern rent levels
• Indexing HRA limits to inflation or housing cost indicators, allowing automatic updates
• Reclassification of metro cities, as many non-metro cities now have metro-level rents
• Allowing a restricted HRA-style deduction under the new tax regime, without undermining its simplicity

Budget 2026: What Could Be Expected

It is still unclear whether Budget 2026 will include provisions for the HRA. However, any revisions to this area will require the Government to balance revenue considerations against relief for taxpayers, especially during a period of introducing a new tax system designed to encourage a greater acceptance rate among taxpayers. It appears unlikely that there will be an overhaul re-structuring; however, the limits may be rationalised or targeted relief may be provided, particularly in view of the importance of housing affordability policies and to ensure stability among our urban workforce.

Currently, the HRA exemption remains a significant source of tax relief for salaried taxpayers, yet ever-increasing rents have caused the value of the exemption to decline steadily over the years. Budget 2026 presents an opportunity to update the HRA provisions to be consistent with current housing costs, and should provide a meaningful improvement to the HRA provisions, thereby providing a genuine financial benefit for millions of people and substantially impacting housing affordability.

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