There is a lot of confusion among landlords about Section24, also known as the ‘Tenant Tax’. In this article, we’ll explain what you needto know about Section 24 to keep you up to date.
The government introduced Section 24 of the Finance Act 2015 in April 2017. In simple terms, Section 24 removes a landlord’s right to deduct mortgage interest and other finance costs (such as mortgage arrangement fees) from their rental income before calculating their tax liability.For the 2020/2021 tax year and beyond, landlords will only be able to claim a tax credit of 20% based on their loan and mortgage interest.
The introduction of Section 24 is a huge change because it will put some landlords into a higher tax bracket.Landlords with significant mortgage commitments could even end up paying more tax on minimal profits, pushing them into the red.
Why did the Government Introduce Section 24?
Section 24 is part of a wider set of measures designed toslow down the growth of the private rental sector. In 2015 chancellor GeorgeOsborne introduced Section 24 due to fears of a property bubble developing. Ifthis bubble had burst, it would have caused huge damage to the wider economy. Bymaking it harder for landlords to profit on buy to let properties, it wouldremove some of the less professional landlords from the sector and slow themarket down. This would boost stability for tenants and make it easier forfirst-time buyers to gain a foothold on the property ladder. It would also makeflipping less profitable, leaving more properties available for purchase.
Of course, experts disagreed with this sentiment. Theywarned that landlords would have to hike rents to cover the inevitable fall inrental yields and many landlords would end up making a loss. The landlords thatwere willing to continue would have no choice but to try different business modelssuch as converting larger family homes into HMOs and flats to boost yields.
Who is Affected by Section 24?
Any landlords incurring finance costs are affected bySection 24. This includes so-called accidental landlords, landlords running aproperty business as an individual, in a partnership, or through a propertytrust. Non-UK resident landlords with residential properties in the UK are alsoaffected.
Landlords who operate their propertyrental business through a company in the UK or outside the UK areunaffected by Section 24. Landlords with furnished holiday lets are alsooutside the remit of Section 24. For now, at least.
Which Costs can no Longer be Claimed Under Section 24?
Mortgage interest is the main cost that can no longer beclaimed, but there are others, including:
- mortgage arrangement fees
- penalties associated with settling a mortgageearly
- interest payable on loans taken out to renovateor refurnish a property
Tax deductible expenses checklist
How Does Section 24 Work?
Under Section 24 rules, landlords can no longer off-setfinance costs against their gross profit when tax liability is calculated. Thismeans they pay more tax. So, if a landlord is on the threshold of a higher taxbracket, the loss of this tax relief could push them into the next tax band.
An increase in gross income may also impact child benefit,child tax credits, and student loan repayments.
Is the Introduction of Section 24 Already Having an Effect?
The private rental market has slowed down recently, surveysshow that many smaller landlords have either left the PRS or are consideringdoing so. Data from Savills Estate Agent published at the end of last yearrevealed that more than 100klandlords have left the sector since 2017.
Of those who remain, there has been an increase in thenumber of properties being run through limited companies, which are unaffectedby the new rules.
How to Off-set Section 24
There are several ways to eliminate or reduce the impact ofSection 24.
Sell up and leave the sector
This might be an option if you are an accidental landlord oryou are ready to quit for other reasons. Nobody would blame you, of course, butbear in mind it could take a while to sellyour properties. The property market is still in a depression, and houseprices are stagnant in many areas.
Let’s also not forget the human cost of such a move. You mayhave to evict any tenants currently living in your properties unless you planto sell with tenants in situ. Either way it is an upheaval for both you andyour tenants.
Reduce your portfolio
If leaving the sector isn’t on the cards, consider whetherselling your least profitable properties is a good idea. There’s no pointkeeping properties that are costing you money in the long-term.
Increase property rents
Work out how much extra tax you will pay at year-end and increasethe rents on your properties to offset the bill. Be careful not to priceyourself out of the local market, an empty property is a huge drain on yourfinances.
If rent hikes are the only solution, it might be worthcarrying out some improvementsto your properties, to justify the rent increase.
Incorporate
Limited companies are exempt from Section 24, so one way tobeat the system is to move your portfolio into a limited company. However, thishas repercussions in other areas, in particular, Stamp Duty Land Tax and CapitalGains tax. You may also be hit with early repayment charges from your mortgagelender. Speak to an accountant before you go down this path.
Transfer your properties to a lower-income spouse/partner
Transferring ownership of rental properties might be advantageous for landlords in a higher tax bracket (or likely to be with the loss of tax relief on property finance). If a spouse or partner pays basic rate tax or no tax at all, this can reduce the amount of tax payable on rental income. Don’t do this without seeking advice from an accountant, and of course, make sure you trust the person you’re transferring it to.
Change the division of profits in a partnership
Landlord partnerships should look at their division ofprofits to offset the extra tax. Transfer a greater percentage of profits to apartner in a lower tax bracket or bring in a lower tax paying spouse or anotherrelative as a business partner.
Switch to commercial properties
Commercial rental properties are exempt from Section 24.This makes them an attractive proposition for landlords. Retail units are anobvious choice, but there are many others worth considering, such as offices,warehouses, and self-storage units.
Even if you don’t want to completely overhaul your businessmodel, diversifying some of your portfolio is not a bad idea.
Reduce your property finance costs
Mortgage interest rates are historically low right now, butthere is no guarantee they will stay that way. Look for the cheapest mortgagedeal possible and if you have property loans, find cheaper finance. The lessinterest you’re paying on your finance, the less out of pocket you will be atyear end.
Cut costs elsewhere
How often do you review your business operating costs? Takea good, hard look at your costs and see if there are any areas where you canreduce your annual expenditure. We’ve already mentioned finance costs, butdon’t forget, if you can save money in other areas, such as insurance orproperty management fees, this will save you money overall.
Go over your business plan with a magnifying glass.Remember, every little helps!
Be Careful not to Fall into a Higher Tax Bracket
With any changes you make, such as increasing rents or modifying your portfolio, be very careful not to inadvertently fall into a higher tax bracket. There’s no point paying more tax for no good reason. If in doubt, run the figures by or talk to an experienced accountant. There may be areas where you can save money that you hadn’t considered.
