How Can Landlords Go Around Section 24 Challenges?

Nikka Sulton

How Can Landlords Go Around Section 24 Challenges?

Section 24 of the Finance Act 2015, also known as the ‘Tenant Tax,’ poses significant challenges for today’s landlords. It imposes substantial financial burdens by altering how landlords can deduct expenses.

Section 24 removes the ability to deduct most finance-related expenses, including mortgage interest and arrangement fees, before calculating tax liability on rental income. Landlords now pay tax on their total rental income, often pushing them into higher tax brackets, potentially affecting the profitability of their portfolios.

To cope, many landlords have raised rents to offset the added tax costs, leading to the unfortunate ‘Tenant Tax’ label as tenants bear the brunt of rising rents.

Why does Section 24 exist?

The Government Stated:

Buy-To-Let (BTL) investors received disproportionate financial support compared to owner-occupiers for mortgages.
The new regulations aimed to increase the housing supply for residential buyers, especially first-time buyers.
Revising mortgage tax relief on BTL mortgages was intended to curb speculation in the housing market.
The Bank of England expressed concern that a potential decline in house prices could be worsened if landlords sold properties to exit or consolidate their positions.
The Government aims to enhance professionalism in the industry.

What can landlords do about section 24?

Landlords have been getting in contact and asking what they should be doing. Tax Policy Associates doesn’t, and can’t, provide tax advice – but it’s a fair question. Here’s a quick summary of how we see things:

Section 24 of the Finance (No. 2) Act 2015 amended the UK tax code to restrict landlords’ ability to deduct their mortgage interest costs from their taxable rental income.

1. Incorporate

Engage a qualified tax adviser, incorporate a company, and transfer your property business to that entity. This allows full deduction of mortgage interest against the company’s corporation tax. However, key considerations include:

New Mortgage Terms: Your current lender is unlikely to transfer the existing mortgage to the new company. Obtaining a new mortgage may entail higher costs (interest and fees). Assess whether these costs outweigh the tax benefit.
Stamp Duty: Transferring to a company may incur stamp duty up to 15%, with an additional 2% for non-residents. Retrospective partnership claims for married couples might not effectively escape stamp duty, as recent legal cases highlight.
Capital Gains Tax (CGT): Property transfer to the company may trigger CGT. While CGT incorporation relief is possible, proving a “business” to HMRC can be challenging. Complex structures may jeopardize incorporation relief, resulting in higher overall taxes.
Double Taxation: The company incurs tax on profits with a deduction for interest costs. When the company distributes profits to you (dividends, wages, or capital gains), a second level of tax applies. Thorough calculations are essential to account for this double taxation scenario.

2. Don’t Incorporate

Maintain your current approach, accepting the expense of non-deductible interest under Section 24.

Alternatively, consider reducing leverage to avoid incurring an after-tax loss, recognizing that this requires deploying additional capital.

3. Sell-Up

It’s possible that neither of the initial two options is viable, as Section 24 renders your rental business financially impractical, consistent with Osborne’s intent.

In such a scenario, selling up might be necessary. It’s not an acknowledgment of failure but a recognition that investors must adjust to changing circumstances.

What is the fourth choice?

There isn’t a one-size-fits-all solution.

Trusts, LLPs, offshore arrangements – not only are they likely to fail when challenged, but the consequences could be far worse than doing nothing at all. Potential six-figure sums in SDLT plus CGT, coupled with intricate structures, can lead to complex and expensive additional tax implications.

Whether you’re a multinational executing a £10bn M&A transaction or a landlord contemplating incorporating a one-property business, the crucial tax question remains constant: “How much do I gain if this succeeds, and how much do I stand to lose if it goes awry?”

How can Less Tax 4 Landlords help landlords with a Section 24 problem?

No need for remortgage or title change, eliminating CGT or Stamp Duty.
A lender-friendly business structure tailored to your needs.
Seamless succession planning, offering protection in case of marital break-up.

Depending on your business needs, benefit from:

Full relief for finance and mortgage costs under Section 24 Tax Changes.
Reduced Capital Gains Tax on Portfolio Reinvestment.
Inheritance Tax mitigation within two years of trading.
A maximum Tax Rate of 20% on your property income.

How might Section 24 be hurting your Property Business?

Section 24 can have various adverse impacts on your property business:

Inflated Profits: Your profits are artificially increased.
Higher Tax Bracket: You may find yourself in a higher-rate tax bracket.
Larger Tax Bill: Expect a substantially larger tax bill.
Uncertainty: Increasing tax bills create business planning uncertainty.
Cash Flow Impact: It affects your cash flow negatively.
Stalled Portfolio Growth: Plans to expand your property portfolio are on hold.
Property Sales: Selling properties to cover tax bills becomes a necessity.
CGT Concerns: Selling one property triggers CGT bills on others.
Retirement Risks: Your retirement plans face potential challenges.
DIY Approach: Spending more time on tasks to cut costs becomes a necessity.

The impact of Section 24

For landlords reporting rental profits in personal names, April 2020 marks the culmination of the 4-year transition period initiated by the government to ease the impact of Section 24. This phased implementation implies that the payments made on account from 2018 to 2021 are likely lower than the actual tax bill when filing tax returns.

This phenomenon, termed the ‘tax escalator effect,’ is visually depicted in the bar chart above. The table below specifies when the balancing payments for each stage of the implementation period become due.

Tax Year	Deductible % of finance costs	Basic Tax Credit	Balancing Payment Due
2017 to 2018	75%	25%	January 2019
2018 to 2019	50%	50%	January 2020
2019 to 2020	25%	75%	January 2021
2020 to 2021	0%	100%	January 2022

As evident from the information above, January 2019 marked the initial balancing payment for a tax year impacted by Section 24 – the 25% deduction. Landlords might assume that the rise witnessed in 2019 constitutes 25% of the total increase by January 2022.

However, the reality is different; the 2019 increase for many landlords will be significantly less than 25% of the overall increase by 2022. This is because Section 24 often leads landlords into higher tax brackets and results in the loss of personal allowances over time, thereby subjecting them to higher tax rates.

When Section 24 Multiplies Your Taxable Profit by 400%

Let’s examine John’s* portfolio with £250,000 gross rental income, £50,000 allowable expenses, and £150,000 finance costs. Due to Section 24, John’s taxable income has surged from £50,000 to £200,000, resulting in a tax bill calculation:

– £12,500 @ 0% = £0

– £37,500 @ 20% = £7,500 (tax bill on £50,000 without Section 24)

– £50,000 @ 40% = £20,000 (now a higher-rate taxpayer)

– £25,000 @ 60% = £15,000 (lost all personal allowance)

– £25,000 @ 40% = £10,000

– £50,000 @ 45% = £22,500 (now an advanced-rate taxpayer)

Total Tax on £200,000 = £75,000

Minus Tax Credit £150,000 @ 20% = (£30,000)

Net Tax to Pay = £45,000

This chart illustrates that by the time John settles his 20/21 tax bill, the resulting tax will leave insufficient income to cover basic living expenses in London, highlighting potential financial challenges if he overlooks these impending changes.

A landlords’ tax example under Section 24

In this example, we’ll consider the impact of Section 24, which has been in full effect since 2021. This section eliminates the ability to deduct mortgage finance costs, although a 20% basic rate deduction may be available, as explained below.

Fred’s income remains at £42,000 from his job and £20,000 from his rental property. For this illustration, we haven’t factored in any tax already deducted from his employment income.

His mortgage costs are still £9,000, and maintenance expenses amount to £1,000. Fred doesn’t have any unused finance costs carried forward.

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

Fred will pay no tax on the first £12,570 of his income, falling under his personal tax allowance (2022/23).

He’ll pay 20% tax on the next £37,699, which falls within the basic 20% tax band.

Finally, he’ll pay 40% tax on the final £10,731 of his income, as it exceeds £50,270 and enters the higher tax band.

Since the finance costs (without carry-forwards) are lower than property profits and adjusted net income, a 20% tax reduction is applied to the finance costs of £9,000. This results in an additional relief of £1,800 deducted from the total tax payable of £11,832.20.

Fred’s final tax bill under Section 24 now appears as follows:

– £61,000 Gross income

Tax Calculation:

£12,570 @ 0% (falls under Personal Tax Allowance)
£37,699 @ 20% Basic rate tax = £7,539.80
£10,731 @ 40% Higher rate tax = £4,292.40

Total tax payable = £11,832.20

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

Final tax payable = £10,032.20

The outcome is that Fred now has to pay £1,800 more in tax compared to what he would have paid before Section 24 was introduced. This is despite the fact that Fred’s salary and rental income have remained unchanged.

Additionally, due to the introduction of Section 24, Fred finds himself in a higher tax bracket, which could have more significant implications as his employment income increases in the future.

The implementation of Section 24 can also bring other drawbacks, 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 just one or two properties, like our example, Fred. They are more likely to be pushed into the higher rate tax bracket, making the impact even more pronounced.

What counts as ‘Finance Costs’ in Section 24?

To clarify how Section 24 affects residential landlords, ‘Finance costs’ encompass:

Mortgage interest
Interest on loans for furnishings
Fees associated with mortgage or loan acquisition or repayment

It’s important to note that tax relief typically doesn’t apply to capital repayments of a mortgage or loan, and the tax credit only pertains to the recently disallowed finance costs, not capital repayments.

Will Section 24 ever be repealed?

The possibility of repealing Section 24 exists, as it has been reversed in other countries. For instance, Ireland had similar measures in place from 2009 but began extending relief to landlords again from 2017. In Ireland, the deductibility of interest on residential mortgages increased back to 100% after a series of increments:

Prior to 2017, 75% of the interest
In 2017, 80% of the interest
In 2018, 85% of the interest
From January 2019, 100% of the interest

While the repeal of Section 24 may occur in the future, it’s unlikely to happen during the current government term. You can find more insights on this topic in an interview with LT4L Co-Founder and Group Director Chris Bailey on Property Tribes: “Are HMRC Finished with Landlords?” – Interview with Chris Bailey.