Understand Section 24 Tax Changes for Landlords

Nikka Sulton

Understand Section 24 Tax Changes for Landlords

Understand Section 24 Tax Changes for Landlords. Section 24, often familiar to landlords, brings increased taxes, reducing profits in the residential rental property sector. Many landlords are concerned about these changes.

To address whether it’s possible to avoid Section 24 tax altogether, let’s dive into the essentials of Section 24. We’ll explain how it functions and its implications for landlords.

The Government introduced section 24 tax changes in 2015, fully implementing them in April 2020. Private landlords, especially those in higher tax brackets, might be impacted.

What is Section 24?

Section 24 is a UK tax law amendment that affects income from residential rental properties. This change limits the income tax relief landlords receive for property finance expenses.

Currently, landlords can only get a 20% tax credit based on their loan and mortgage interest payments. It has also pushed some landlords into higher tax brackets, increasing their tax payments and reducing profits.

Why was it introduced?

The Section 24 tax was implemented as part of a strategy to curb the rapid growth of the private rental sector. When it was introduced, there were concerns about a potential property “bubble” forming, which could have adverse effects on the broader economy.

The primary aim of Section 24 is to reduce the profitability of buy-to-let properties, making it less attractive for landlords and potentially leading some to exit the sector. This slowdown in the market is seen as a way to address the perceived issues associated with a rapidly expanding rental market.

Additionally, Section 24 has the effect of making property “flipping” less lucrative, discouraging this practice. As a result, fewer individuals engage in flipping properties, which, in turn, increases the supply of properties on the market. This increased supply can benefit first-time buyers, making it easier for them to enter the property market

How does Section 24 work?

Section 24 represents a significant change for landlords, as it mandates that they must pay income tax on their entire rental income, with the option to claim back a maximum of 20% in tax relief.

To illustrate how this works, consider an example: Let’s assume your rental income amounts to £15,000, and your interest payments on the property amount to £5,000.

Firstly, you will be required to pay tax on the full rental income.
For basic rate taxpayers (taxed at 20%), this tax would amount to £3,000. For higher rate taxpayers (taxed at 40%), the tax would be £6,000.
You can then claim back 20% of your interest payments, which is £1,000 (as £1,000 represents 20% of £5,000).
Consequently, basic rate taxpayers would pay a total of £2,000 in tax, while higher rate taxpayers would pay £5,000 in tax.

This example illustrates that Section 24 has a more substantial impact on higher-rate taxpayers. The intention behind this is to dissuade potential landlords from entering the private rental sector.

Understanding Tax Relief Changes

Section 24 has ushered in substantial changes in how landlords are taxed on income from residential rental properties. In the pre-Section 24 era, landlords could deduct mortgage interest from their income tax. They could also claim deductions for various rental property expenses, such as mortgage admin fees or loans for furnishing.

However, with the advent of Section 24, landlords now face taxation on the entirety of rental income. Their only reprieve is the ability to claim back mortgage interest costs, limited to 20%—equivalent to the basic rate of income tax.

This shift translates into increased upfront tax payments for landlords. Additionally, if they have other sources of income, like a job salary, their rental income may push them into higher tax brackets, leading to an overall higher tax liability.

In essence, Section 24 prohibits landlords from offsetting finance charges against their gross profit when calculating tax liabilities. This change may push landlords on the brink of a higher tax bracket into that next tier. The rise in gross income can also affect other financial aspects, including student loan repayments, child tax credits, and child benefits, all contingent on income changes.

Tax Relief for Landlords in 2023

Under the restructured tax rules of Section 24, landlords qualify for a 20% tax credit based on the lowest of three factors:

Finance costs, encompassing mortgage interest, loans for furnishing purchases, and related fees.
Property business profits.
Adjusted total income.

This adjustment implies that landlords can no longer fully deduct finance costs, including mortgage interest, from rental income for tax purposes. Instead, they receive a 20% tax credit based on the lowest of these three elements.

Who’s Affected by Section 24 and Its Tax Relief Changes?

The impact of these tax relief rules extends broadly, affecting individual landlords in the private rented sector. This includes various scenarios:

UK-resident landlords renting out properties in the UK or abroad.
non-UK resident landlords with UK rental properties.
Landlords using partnerships to let properties.
Landlords operating as limited liability companies, subject to a distinct tax system, allowing them to declare rental income after accounting for mortgage costs.

The government’s policy paper on finance cost relief estimated that only a fifth of individual landlords would experience reduced relief under the new regulations. Notably, higher-earning landlords shoulder the primary impact of these changes.

Consequently, landlords must now pay tax on their gross rental income, potentially pushing some into higher tax brackets.

Government Response to the Petition for Full Tax Relief Reinstatement

The impact of Section 24 on the rental property market prompted a petition signed by many landlords. This petition highlights the consequences of Section 24 on the rental stock and the potential benefits of restoring full relief.

Signatories, including Marc von Grundherr, Director of Benham and Reeves, emphasize these changes’ significant influence. According to a landlord survey, 73% of those contemplating exiting the sector would reconsider if Section 24 changes were reversed.

In response, the government remains firm in setting mortgage interest relief against rental income at the basic tax rate. Their aim is to maintain fairness within the income tax system and avoid granting landlords advantages beyond what homeowners receive.

While the petition faces further challenges, it could trigger a parliamentary debate if it reaches 100,000 signatures.

Using Section 24’s Impact on Your Portfolio

To alleviate Section 24’s impact and manage changes in interest relief, landlords have various options beyond raising rent, which may not always be effective:

Market Dynamics: Rental rates are market-driven. Overpricing can lead to longer vacancies and financial losses. Aligning rent with market rates is crucial.
Property Upgrades: Justifying higher rent with property improvements can lower your property’s value and tax bracket.

Alternative strategies include reviewing operating expenses, self-managing properties, exploring remortgaging, and diversifying into commercial property investments. Consultation with financial and property experts is advisable to tailor solutions to individual circumstances.

Is there a way around the changes?

Yes! Landlords have the option to establish a limited company to purchase a property or transfer ownership of an existing one to that company.

The current corporation tax rate stands at 19%, and it is slated to decrease to 17% in 2020. This rate is significantly lower than the 40% higher rate and the 45% additional rate of personal income tax. As a business expense, mortgage interest can be entirely offset against tax when operating as a limited company.

However, this approach may not be suitable for everyone. When transferring a property to a company, you are likely to incur stamp duty and capital gains tax since the legal ownership of the property changes hands. Additionally, when you wish to withdraw money from the company (unless you plan to reinvest all of it), you will be subject to further taxation. The first £2,000 of dividends can be received tax-free, but subsequent amounts are taxed at rates ranging from 7.5% to 38.1%, depending on your tax band.

Securing a mortgage as a company might pose some challenges, although an increasing number of lenders are now offering limited company buy-to-let mortgages. If you opt for the limited company route, it is advisable to engage an accountant who can assist in determining the most tax-efficient method for managing your income.