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, in effect since the tax year 2020/21, has greatly diminished tax relief for landlords. It has reversed many tax advantages once available to property investors.

In this guide, we’ll delve into the details of Section 24, its implications for your buy-to-let portfolio, and strategies you can employ to minimize the impact of increased tax liability.

What is Section 24?

In 2015, the announcement of Section 24 set a significant change in motion, fully implemented in April 2020. This regulation caps income tax relief on property finance costs at 20%.

This marks a substantial reduction in tax relief compared to the previous system. Previously, landlords could subtract mortgage interest and other property finance expenses (e.g., admin fees, loan interest for furnishings) from rental income before calculating their tax liability.

Since 2020, property finance costs can no longer be subtracted from rental profits pre-tax. Instead, tax relief has been replaced by a 20% tax credit based on the landlord’s mortgage interest payments.

Why Was The Section 24 Reforms Introduced?

The Section 24 tax changes have several objectives. Firstly, the government aims to discourage property investment by landlords, thereby reducing the number of individuals owning multiple properties and slowing property appreciation.

Secondly, it seeks to limit tax relief for higher-income individuals, preventing them from claiming substantial amounts.

Lastly, these changes aim to expand the housing stock and provide opportunities for first-time homebuyers. The substantial rise in property values has created significant financial barriers for first-time buyers.

Who is affected by the changes?

These changes affect residential landlords who fall into the following categories:

UK residents renting out properties in the UK or abroad.
Individuals involved in partnerships that rent out residential properties.
Trustees or beneficiaries of trusts liable for UK income tax on residential rental properties.
Non-UK residents renting out residential properties 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 every residential landlord with property finance costs is affected, not all will experience an increase in their tax liability.

How does Section 24 work?

Under the new rules, landlords are taxed on their rental earnings (after allowable expenses) and then receive a 20% tax credit on annual mortgage interest. Here’s an example:

Landlord charges £1,300pcm rent, pays £375 monthly mortgage interest, and has other monthly expenses averaging £300.
Taxable rental income is £12,000, with £4,500 annual mortgage interest.
For basic rate taxpayers, income tax owed is £2,400.
They get a tax credit of £900.
Total tax bill is £1,500.

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

Buy-to-let landlords can deduct allowable expenses from their gross rent, which includes costs like maintenance. Tax is then calculated on the rental income after deducting these expenses.

Allowable expenses encompass:

Letting agencies and property management fees
Utility bills and council tax
Service fees (e.g., cleaning and gardening)
Maintenance and repair costs that restore the property or item to its original condition without enhancing it.

The relief on the following costs is now limited, and payments cannot be deducted when calculating taxable profit. Instead, a percentage can be reclaimed after determining taxable profit:

Mortgage interest
Interest on loans used for furnishing the property
Interest on overdrafts, administration, and related costs tied to mortgages or alternative financial arrangements.

Section 24 primarily impacts financing repayment claims, not ongoing property maintenance and management expenses.

How does the change affect my portfolio?

The impact of Section 24 on landlords varies based on their tax bracket and portfolio size. Basic-rate taxpayers (20%) experience minimal impact as the tax credit refunds the basic rate on mortgage interest.

However, for higher and additional rate taxpayers, the impact is significant. Previously, higher-rate taxpayers effectively received 40% relief on mortgage interest, but under the new rules, they only receive a 20% tax credit, doubling their tax bill.

Landlords near the top of their tax bracket could be pushed into a higher band as mortgage payments must be declared. Combined with income from other sources, rental earnings could cross into higher or additional rate thresholds. Multiple property owners are more likely to experience this due to the new rules.

Example: A landlord with a £12,000 taxable rental income and a £42,000 salary would surpass the higher-rate threshold of £50,270, resulting in a total tax bill of £2,246 after the tax credit.

Before Section 24, the landlord could deduct their £4,500 mortgage interest, keeping their income below the higher-rate threshold. Their taxable rental earnings at the basic rate would lead to a total bill of £1,500, the same as in the original example.

Basic-rate taxpayers face no change, but higher-rate taxpayers see a significant increase in costs under Section 24.

How To Manage The Impact Of Section 24:

For landlords with smaller rental income and portfolios, Section 24’s impact may be relatively modest. However, those with larger portfolios could face significant tax implications. Here are potential actions to mitigate the effects:

1. Cut operating costs: Reduce expenses in property management, such as self-managing instead of using a property management company, to lower overheads.

2. Refinance properties: Take advantage of low interest rates in the post-pandemic economic recovery to remortgage properties for more competitive financing rates.

3. Explore commercial properties or holiday lets: Section 24 applies only to residential properties, so consider switching to commercial properties or holiday lets to avoid the rule, but carefully evaluate the implications.

4. Incorporate as a limited company: Section 24 doesn’t affect limited companies, allowing you to bypass the tax change. However, consider the associated costs, including stamp duty and capital gains tax.

5. Set up a beneficial interest company trust: This structure lets you transfer your portfolio into a company to avoid Section 24 changes while maintaining personal ownership. Be aware of other implications, such as corporation tax and potential remortgaging issues.

6. Increase rent modestly: Raising rents slightly may offset Section 24 expenses, but be cautious not to enter a higher tax bracket.

7. Streamline your portfolio: Review property finances and consider selling underperforming assets to streamline your investments.