A Simplified Guide to Section 24 of Income Tax Act UK

Nikka Sulton

A Simplified Guide to Section 24 of Income Tax Act UK

Landlords often find Section 24, or the ‘Tenant Tax,’ perplexing. Let’s unravel it for you.

In April 2017, the government introduced Section 24 through the Finance Act 2015. In simple terms, it eliminates a landlord’s ability to subtract mortgage interest and related finance costs (like mortgage arrangement fees) from their rental income when determining their tax liability. Starting from the 2020/2021 tax year, landlords can only claim a 20% tax credit based on their loan and mortgage interest.

This change is significant as it may push some landlords into a higher tax bracket. Those with substantial mortgage commitments might even find themselves paying more tax on meager profits, potentially driving them into a loss. Stay informed about Section 24 to navigate these tax implications effectively.

Why did the Government introduce Section 24?

Section 24 is part of a broader strategy aimed at curbing the expansion of the private rental sector. In 2015, Chancellor George Osborne introduced Section 24 as a precaution against the potential development of a property bubble. Such a bubble could have had severe repercussions for the overall economy. By introducing measures that make it more challenging for landlords to profit from buy-to-let properties, the aim was to weed out less professional landlords and slow down the market. This move was intended to enhance stability for tenants and facilitate easier entry for first-time homebuyers, while also reducing the profitability of property flipping, thereby increasing the availability of properties for purchase.

However, it’s worth noting that experts held different opinions on this matter. Some cautioned that landlords might need to increase rents to compensate for the expected decline in rental yields, potentially causing financial losses for many landlords. Those landlords who chose to continue would likely need to explore alternative business models, such as converting larger family homes into houses in multiple occupation (HMOs) and flats to improve their yields.

Who is Affected by Section 24?

Section 24 impacts landlords incurring finance costs, irrespective of their type. This encompasses accidental landlords, individual landlords, those operating as partnerships, and those using property trusts. Even non-UK resident landlords with residential properties in the UK are subject to Section 24.

However, landlords who manage their property rental business through a UK or overseas company remain unaffected by Section 24. The same exemption applies to landlords with furnished holiday lets, at least for the time being.

What deductions are under house property?

Municipal Tax Deduction

Municipal tax represents the annual payment to the local municipal corporation for your property. To calculate the net value of the house property, you deduct these taxes from the gross annual value. The deduction on municipal tax is applicable if it is shouldered by the property owner and paid during the current financial year.

Standard Deduction

A standard deduction of 30% is applied to the calculated net annual value. This deduction remains constant, regardless of whether your property-related expenses are higher or lower. It’s irrespective of costs like insurance, electricity, repairs, water supply, and so on. For self-occupied properties with a nil annual value, the standard deduction is zero.

Home Loan Interest Deduction

Homeowners can claim a deduction of up to ₹2 lakh on home loan interest when the property is occupied by their family or vacant. The same deduction applies when the property is rented out, allowing the entire interest on the home loan to be claimed as a deduction.

What is Section 24 of the Income Tax Act?

Section 24 of the Income Tax Act outlines the specific deductions available to taxpayers with income from house property as per the Income Tax Act, 1961. These deductions are only applicable to those who own house property.

Section 24 comprises two subsections: Section 24(a) and Section 24(b), each addressing different aspects of owning and renting out residential properties.

Section 24(a) pertains to deductions for rental income from house property.
Section 24(b) concerns deductions for annual interest repayment on a home loan used for the purchase or construction of house property.

In the following sections, we will delve into the eligibility and annual deduction limits for both subsections of Section 24.

Considerations for Section 24(a) Deduction:

Section 24(a) deductions apply to the following categories, which are considered income from house property for tax benefits:

Rental Income: If you rent out a property, the rental received is considered as income under Section 24.
Multiple House Ownership: If you own more than one house, the net annual value of the property (as determined under Section 23 of the Income Tax Act) is considered your rental income. The house you reside in is not considered a source of rental income in this scenario.
Single House Ownership: If you own only one house and reside there, the rental income from that property is considered zero.

It’s important to note that income from rent and additional housing property will be taxed after the deductions granted through Section 24 have been claimed.

How Does Section 24 Work?

Before 2017, landlords could subtract their entire finance costs from their rental income when calculating taxable income.

However, this has changed, and now landlords are taxed on their property income before any finance costs.

Let’s consider an example with Fred, a landlord who owns a rental property.
Fred earns an amount of money, A, from his job annually.
His rental property provides an annual income of B, giving him a total income of A+B.
However, he has a mortgage on this property, which costs C each year, and he also has annual property maintenance expenses of D.
Before 2017, Fred’s total taxable income was calculated as A + (B – (C + D)).
Now, with Section 24 fully in effect after 2021, Fred’s taxable income is simply calculated as A + B – D.
There may be a 20% tax reduction available on the lower of the finance costs, property business profits, and adjusted total income, as described above.

How Section 24 affects landlords

In straightforward terms, Section 24 raises landlords’ taxable income, leading to an increase in the total amount of tax they must pay.

This can have a significant impact if the added income pushes them into a higher tax bracket.

Let’s revisit our example with landlord Fred, this time with actual numbers.

Please note that we are using the personal allowance and tax band values from the 2022/23 tax year for both examples to highlight the difference made by the financial cost restrictions introduced by Section 24.

For reference, in the 2021/22 tax year, the personal allowance was £12,570, and the basic rate tax band extended up to £50,270.

A landlords’ tax example under Section 24

Here’s the revised version of the content without flowery language:

Section 24, which has been in full effect since 2021, eliminates the ability to deduct mortgage finance costs, but a 20% basic rate deduction may be available, as explained below.

Fred still earns £42,000 from his job and £20,000 from his rental property. For the sake of this example, we haven’t considered any tax deductions from his employment income.

He still pays £9,000 for his mortgage and £1,000 in maintenance.

Fred doesn’t have any carried-forward finance costs.

His taxable income is now calculated by adding his salary to his rental income and subtracting ONLY his maintenance costs (as mortgage finance costs are no longer deductible). (£20,000 – £1,000 = £19,000) + £42,000 = £61,000

Fred will still pay no tax on the first £12,570 of his income as it falls within his personal tax allowance (2022/23).

He then pays 20% tax on the next £37,699, as it falls within the basic 20% tax band.

Lastly, he will also pay 40% tax on the final £10,731 of his income, as it crosses into the higher band applied to income exceeding £50,270.

Since finance costs (without carry-forwards) are lower than property profits and adjusted net income, a 20% tax reduction is available based on the finance costs of £9,000. This means there’s an additional relief of £1,800 to deduct from the total tax payable of £11,832.20

So, Fred’s final tax bill under Section 24 now looks like this:

– £61,000 Gross income

Tax Calculation:

£12,570 @ 0% (falls under Personal Tax Allowance)
£7,539.80 @ 20% Basic rate tax
£4,292.40 @ 40% Higher rate tax

Total tax payable = £11,832.20

Less relief for finance costs £9,000 @ 20% = £1,800

Final tax payable = £10,032.20

The net result is that Fred now has to pay £1,800 more tax than he would have under the old system, despite his salary and rental income remaining the same.

In addition to increasing his tax bill compared to the previous system, Fred now falls into a higher tax bracket. This could have a more significant impact as his employment income increases in the future.

The introduction of Section 24 can also have further consequences, including the potential clawback of child benefit under the high-income child benefit charge if income exceeds £50,000.

These changes have been particularly costly for landlords with only one or two properties, like our example, Fred, as they are more likely to be pushed into the higher rate tax bracket.

Three alternative routes to Section 24

Leaving aside the concerns regarding the implementation of Section 24, landlords have three alternatives they’re pursuing instead of immediately selling a rental property.

Partner route

One potential method to deal with the tenant tax is to transfer property to a lower income partner, or at least transfer some or all of the income via a legal Partnership arrangement validated by HMRC.

If a landlord’s spouse or partner pays either basic tax, or no tax at all, then transferring property can substantially reduce the amount of tax payable on rental income. But you must not do this before seeking advice from an accountant.

Limited company route

Another way to address Section 24 is by transferring your property to a limited company. Limited companies are exempt from Section 24, allowing you to offset 100% of mortgage interest as a business expense against tax. Furthermore, the UK’s current corporation tax rate stands at 19%, significantly lower than the 40% higher band tax rate.

However, this option may not suit everyone. Transferring a property to a company may entail paying stamp duty and capital gains tax unless you can claim Incorporation and Stamp Duty Reliefs by demonstrating that you spend approximately 20 hours per week managing a portfolio of properties. If you have just a few buy-to-let properties, this approach may not be viable in the eyes of the Inland Revenue. Additionally, extracting money from the company could lead to a double tax charge, first through corporation tax and then again when you withdraw profits personally. It’s also worth noting that securing a mortgage as a company can be more challenging and expensive compared to obtaining a Buy-to-Let mortgage in your personal name, with higher arrangement fees and interest rates for limited company mortgages. Consulting with an accountant can help you determine if the limited company approach is the most efficient for your situation, particularly if you plan to build your investment over an extended period due to the inherent tax advantages for limited companies.

Holiday let route

Many landlords are opting to switch their private rental properties to the holiday home sector. Furnished holiday lets enjoy an exception from Section 24 of the Finance Act 2015, treating them as a trading business. Consequently, finance costs associated with a holiday let can be offset against tax.

Moreover, holiday lets can yield higher income compared to traditional buy-to-let properties. However, not every property is suitable for conversion into a holiday let. Managing a holiday let involves significantly more work than owning a standard buy-to-let property.

It’s important to note that some lenders impose intricate restrictions on the use and marketing of holiday lets. Legally, a property must be available for at least 210 days a year and let for at least 105 days to qualify as a holiday let. Long-term accommodation periods exceeding one month and totaling more than 155 days are not permitted.

An intriguing aspect of holiday let properties is that if you have multiple mortgaged buy-to-let properties, it can be advantageous to place most of your debt on one property designated as a holiday let. This allows you to continue offsetting the finance costs against tax.

Before converting a property into a holiday let, it’s advisable to consult with an accountant to ensure it aligns with your financial objectives, as there are numerous tax considerations involved.