A Guide to Section 24 Tax Change For Buy-to-Let Investors

Nikka Sulton

A Guide to Section 24 Tax Change For Buy-to-Let Investors

Section 24 tax provisions came into full effect for the tax year 2020/21, marking a significant change in the tax landscape for landlords. These provisions, introduced over several years, have substantially reduced the tax relief landlords can claim, reversing several key tax advantages previously available to property investors.

In this guide, we will delve into the details of Section 24, explaining what it means for your buy-to-let portfolio and outlining actionable steps to minimize the impact of the increased tax liability. Understanding the nuances of Section 24 is essential for any landlord navigating the evolving tax environment in the UK property market.

What’s Section 24?

In 2015, the announcement of Section 24, which took full effect in April 2020, brought a significant change to the taxation of property income. This regulation restricts income tax relief on property finance costs to the basic rate of 20%.

This marks a substantial reduction in the level of tax relief available to landlords compared to the previous system. Prior to the implementation of Section 24, landlords could deduct mortgage interest payments and other property finance costs from their rental income before calculating their tax liability.

However, from 2020 onwards, property finance costs can no longer be subtracted from rental profits before taxation. Instead, they are replaced by a tax credit equal to 20% of the landlord’s mortgage interest payments. Understanding the implications of this change is crucial for landlords as it affects the taxation of property income in a significant way.

Why Were The Section 24 Reforms Introduced?

The Section 24 tax changes have several objectives. Firstly, the government aims to dampen the appeal of property investment in the private rental market, discouraging landlords from expanding their property portfolios. This strategy seeks to reduce the number of individuals owning multiple properties, thereby increasing the supply of properties on the market and slowing down property price appreciation.

Secondly, it’s designed to restrict higher earners from claiming substantial amounts of tax relief. The intention behind this measure is to focus tax increases on individuals with higher incomes.

Lastly, it’s aimed at expanding the housing stock and providing first-time homebuyers with an opportunity to enter the property market. With property values rising significantly in recent decades, first-time buyers face significant financial barriers to entry.

Who is affected by the changes?

These changes affect residential landlords under the following conditions:

UK residents who rent out properties in the UK or overseas.
Individuals involved in partnership arrangements for residential property rentals.
Trustees or beneficiaries of trusts liable for UK income tax on residential rental properties.
Non-UK residents renting out residential property in the UK.

It’s important to note that these tax relief changes do not impact holiday rentals, commercial properties, or residential properties owned by registered companies. While all residential landlords with property finance costs are affected, not everyone will experience an increase in their tax liability.

How does Section 24 work?

Under the new regulations, landlords are now required to pay tax on their entire rental earnings after deducting allowable expenses. They can then claim a tax credit equal to 20% of their annual mortgage interest.

To illustrate this:

Let’s consider a landlord who charges £1,300 per month in rent, has monthly mortgage interest costs of £375, and incurs additional expenses averaging £300 per month.

Their taxable rental income amounts to £12,000, while their annual mortgage interest stands at £4,500.

If they fall into the basic rate taxpayer category, their income tax liability is £2,400.

They are eligible for a tax credit of £900.

This results in a total tax bill of £1,500.

We’ll delve into a detailed comparison with the previous rules shortly.

How does the change affect the portfolio?

The impact of the tax changes brought by Section 24 depends on your income tax bracket and the size of your property portfolio. Landlords falling into the basic 20% tax bracket experience a minimal impact, as the tax credit offsets the basic rate on mortgage interest.

However, for landlords in higher tax brackets, which is common among property investors, the impact is more substantial. In the previous tax regime, higher-rate taxpayers effectively received a 40% relief on their mortgage interest payments. Under the new rules, they only receive a 20% credit, effectively doubling their tax liability.

Furthermore, landlords close to the top of their tax bracket might find themselves pushed into a higher tax band because income used for mortgage payments needs to be declared on their tax return. When combined with income from other sources, such as salary or pension, their rental earnings could push their total income above the higher (£50,270) or additional (£150,000) rate thresholds. Landlords with multiple properties are more likely to experience this change in tax status due to the new rules.

Let’s revisit our previous example to see how this works in practice:

Suppose a landlord has a taxable rental income of £12,000 to declare in the 2021/22 financial year and earns a salary of £42,000 per annum. This additional rental income pushes them over the higher-rate tax threshold of £50,270. With a total taxable income of £54,000, the landlord would owe £1,654 in tax on the first £8,270 of their rental income and £1,492 on the next £3,730. The total tax bill before the credit is £3,146. After applying the tax credit of £900, the final bill is reduced to £2,246.

In contrast, before Section 24, the landlord would have been able to deduct their mortgage interest payments of £4,500 from their taxable income, keeping their overall income below the higher-rate threshold at £49,500. The taxable earnings from their rental property would be £7,500, taxed at the basic rate of 20%, resulting in a total bill of £1,500, the same as in our original example.

The comparison of these two examples illustrates that basic-rate taxpayers see no change in their final tax bill under Section 24, while those in higher tax brackets face a significant increase in costs.

How can I reduce the impact of Section 24 on my portfolio?

In response to Section 24 tax changes, many landlords have considered raising rents. However, this approach can have unintended consequences:

Tax Implications: Increasing rent may push landlords into a higher tax bracket, negating the gains and leading to higher tax liabilities.
Market Dynamics: Rental property values are influenced by the market, and excessive pricing can result in longer vacancy periods, leading to costly voids.
Property Upgrades: To justify higher rents, landlords might need to invest in property improvements, which can be expensive.

While adjusting rents may be necessary in some cases, it’s wise to explore alternative solutions that won’t impact your tax status significantly.

Another option considered by many landlords is incorporating as limited companies, which aren’t affected by Section 24 reforms. However, this decision comes with several considerations, including:

Tax Liabilities: Limited companies are subject to corporation tax, and transferring properties to the company can incur stamp duty and capital gains tax.
Fees and Penalties: Costs like remortgaging fees and early repayment penalties from lenders can apply.

If you haven’t already, consult with an accountant to discuss your portfolio and receive tailored advice. Various financial planning strategies can help mitigate losses, and an accountant can recommend the best approach based on your unique circumstances.

In the meantime, here are steps to minimize the impact of Section 24 on your portfolio:

Refinance Properties: Take advantage of historically low interest rates to refinance your properties with more competitive loans, reducing your mortgage interest expenses.
Portfolio Review: Evaluate the performance of each property and consider selling underperforming assets that increase your taxable income without delivering significant returns.
Operating Cost Review: Reduce operational costs by exploring cost-effective alternatives to traditional letting agents. Proptech solutions can help streamline property management and reduce fees.

If you prefer a hands-off approach, consider Home Made’s hybrid lettings solution, which offers cost savings, efficient tenant management, and improved customer service. Their landlord platform, The Property Wallet, provides exceptional tenant-find and property management services with transparent pricing options, allowing you to spread marketing costs or pay upfront. Prices start at just £50+VAT per month for tenant-find and £60+VAT per month for management, or you can choose a one-off upfront fee of £1,200+VAT for tenant-find.

What Expenses Are And Aren’t Allowable Under Section 24?

Buy-to-let landlords can still subtract allowable expenses from their gross rent, which includes expenses like maintenance, before paying taxes on the remaining rental income.

Allowable expenses encompass:

Letting agencies and property management fees.
Utility bills and council tax.
Fees for services like cleaning and gardening.
Maintenance and repair costs that restore the property or items within it to their original condition without making improvements.

However, relief for certain costs is now restricted, and these payments can’t be deducted when calculating taxable profit. Instead, a percentage can be claimed back after determining the taxable profit. These costs include:

Mortgage interest.
Interest on loans used to furnish the property.
Interest on overdrafts, administration, and other associated costs related to mortgages or alternative financial terms.

It’s worth noting that Section 24 primarily impacts financing repayment claims rather than ongoing property maintenance and management expenses.