Draft Income-tax rules 2026: What’s changing in HRA exemption for salaried employees

The Centre is proposing a significant expansion of House Rent Allowance (HRA) tax benefits for salaried employees under the old income-tax regime, signalling relief for workers in fast-growing urban centres facing rising rental costs. The changes, outlined in the draft Income-tax Rules, 2026, are expected to come into force from April 1, 2026, subject to approval.

Currently, employees living in Mumbai, Delhi, Kolkata and Chennai can claim HRA exemption of up to 50% of their salary, while those residing in all other cities are limited to 40%. The draft rules seek to widen the 50% exemption bracket by adding Bengaluru, Hyderabad, Pune and Ahmedabad — cities that have emerged as major employment hubs over the past decade and have witnessed sharp increases in housing rents.

Once implemented, salaried taxpayers living in these eight cities will be eligible for a higher HRA exemption ceiling, while employees in the rest of the country will continue to fall under the 40% limit. The proposal aligns with the government’s broader effort to update tax provisions to reflect evolving urbanisation patterns and cost-of-living pressures in India’s expanding metropolitan regions.

How the revised HRA exemption will work

Under Rule 279 of the draft Income-tax Rules, 2026, the HRA exemption available to an employee will continue to be calculated using the existing three-step formula. The tax-exempt portion of HRA will be the lowest of the following:

The actual HRA received during the relevant period

Rent paid minus 10% of salary

50% of salary for employees posted in Mumbai, Delhi, Kolkata, Chennai, Bengaluru, Hyderabad, Pune and Ahmedabad, or 40% of salary for employees posted in any other city

For the purpose of calculating this exemption, “salary” will include basic pay and dearness allowance, if it forms part of retirement benefits under the employment terms. Other allowances and perquisites will be excluded from this definition.

Importantly, the HRA exemption will apply only for the period during which the employee actually occupied the rented residential accommodation during the financial year. Any months without rental occupancy will not qualify for the exemption.

Cities eligible for 50% HRA exemption

Under the proposed framework, the cities qualifying for the higher 50% HRA exemption will be:

Existing cities: Mumbai, Delhi, Kolkata, Chennai

Proposed additions: Bengaluru, Hyderabad, Pune, Ahmedabad

All other cities and towns across India will continue to attract a 40% HRA exemption limit.

Old tax regime continues to matter

HRA exemption remains available only under the old tax regime. Taxpayers opting for the new tax regime will not be eligible for any HRA-related tax relief. This distinction reinforces the relevance of the old regime for salaried employees who incur significant rental expenses and rely on exemptions to reduce their taxable income.

The proposed HRA changes add to a series of draft measures that suggest the government is not in a hurry to phase out the old regime, despite the growing popularity of the simplified new system.

Other allowance revisions proposed

Alongside the HRA overhaul, the draft Income-tax Rules, 2026 propose several other upward revisions to long-standing allowances, reflecting inflation and changing cost structures. These include:

Children’s hostel allowance: proposed increase from Rs 300 to Rs 9,000 per month

Children’s education allowance: proposed increase from Rs 100 to Rs 3,000 per month

Interest-free or concessional employer loans: limit raised from Rs 20,000 to Rs 2,00,000

Transport allowance exemption: enhanced to up to 70% of the allowance, capped at Rs 25,000, compared with the earlier Rs 10,000 limit

These revisions are expected to provide additional relief to salaried employees, particularly families with education-related expenses or special mobility needs.

Public consultation and next steps

The draft Income-tax Rules, 2026, along with revised forms, have been placed in the public domain for stakeholder feedback. Comments and suggestions can be submitted for a period of 15 days, until February 22, 2026. After reviewing the feedback, the government will finalise the rules and place them before Parliament for approval.

If cleared, the revised HRA framework and other allowance changes will take effect from April 1, 2026, potentially reshaping tax planning for millions of salaried taxpayers across India.