The Hindu Undivided Family (HUF) is a powerful tool for Indian families, but there’s one critical mistake that can wipe out all the benefits.
The Power of a HUF
An HUF is a separate legal entity and taxpayer in India. It can own assets, run a business, and claim its own tax deductions, just like an individual. By creating an HUF, families can:
- Split income streams and take advantage of an additional tax slab.
- Claim a basic tax exemption of ₹2.5 lakh.
- Get a full ₹1.5 lakh deduction under Section 80C.
- Use capital gains rollovers under Sections 54 and 54F.
It’s a fantastic way to protect and grow inherited or ancestral wealth. For example, a family that inherited ₹1.2 crore used an HUF to earn ₹8 lakh in rent, saving over ₹1 lakh in taxes annually by having that income taxed separately.
The One Mistake to Avoid
The biggest blunder people make is using their personal salary or savings to fund the HUF. When you do this, Section 64(2) of the Income Tax Act kicks in. This “clubbing rule” adds any income the HUF earns from those funds back to your personal income, which means you get no tax benefit at all.
For instance, if you gift ₹50 lakh from your salary to your HUF, the interest earned from that money will be taxed under your name, not the HUF’s. The tax-saving advantage is completely gone.
How to Use a HUF Correctly
To reap the rewards, you must fund the HUF with inherited or gifted ancestral wealth, not your personal earnings.
Who can form an HUF?
Only Hindus, Jains, Sikhs, and Buddhists can create one, and you need a Karta (head) and at least one coparcener. Since the 2005 Hindu Succession Act amendment, daughters are also considered coparceners and can even be the Karta.
While setting up an HUF is fairly simple, using it correctly is key. When managed strategically, it’s one of the most effective tools for wealth and tax planning in India. But when used carelessly, it can quickly lead to tax trouble.