What is Section 24 A? Basic Guide for Landlords

Nikka Sulton

What is Section 24 A? Basic Guide for Landlords

Section 24 of the Finance Act 2015, known as the ‘Tenant Tax,’ has become a significant challenge for landlords in recent times. This legislation fundamentally changes the way rental income is taxed. It removes the ability for landlords to deduct most finance costs, including mortgage interest and arrangement fees, from their rental income before calculating their tax liability.

As a result, landlords are now required to pay tax on the gross income they earn from their rental properties. This change has the potential to push landlords into higher tax brackets, significantly affecting their overall tax liability. For many landlords, this alteration has had a substantial impact on the profitability of their property portfolios.

To cope with the increased tax burden, many landlords have resorted to raising rents on their properties. This move is an attempt to offset the additional tax they must pay due to Section 24. Unfortunately, this strategy has led to the so-called ‘Tenant Tax,’ as tenants are the ones who ultimately bear the brunt of rising rents. This situation has created financial challenges for both landlords and tenants, with landlords grappling with tax changes and tenants facing increased living expenses.

Why was Section 24 introduced?

Section 24 of the Finance Act 2015 was a component of the government’s effort to address the rapid expansion of the private rental sector. This expansion had made it increasingly challenging for first-time buyers to enter the property market.

In addition to Section 24, in April 2016, the government introduced a three percent stamp duty surcharge specifically targeting landlords purchasing second properties. This surcharge imposed an additional tax on top of the standard stamp duty.

The combined effect of these measures was to align with the government’s broader goal of “leveling the playing field” between landlords and first-time buyers in the property market.

When was Section 24 introduced?

Section 24, introduced as part of the 2015 Finance Act by Prime Minister David Cameron and Chancellor George Osborne, aimed to address several issues. One primary goal was to maintain high levels of home ownership while slowing the growth of the private rental sector (PRS). The intention was to reduce demand from buy-to-let landlords, making it easier for first-time buyers to enter the property market.

This legislation was implemented gradually over four fiscal years from 2017 to 2021. Each year, a quarter more of landlords’ finance costs, including mortgage interest and arrangement fees, became non-deductible. This process started with 25% in 2017-18 and reached full implementation in 2020/21.

Simultaneously, HMRC phased in the basic rate relief tax reduction. Landlords could still benefit from a 20% tax reduction based on the lower of their finance costs, property business profits (accounting for brought forward losses), and adjusted income (income exceeding the personal allowance but after losses and reliefs, excluding dividends and savings income). Importantly, this tax reduction couldn’t create a repayment but could be carried forward for future use, subject to specific calculations by tax advisers.

How have landlords responded?

Section 24, also known as the ‘Tenant Tax,’ has faced strong opposition from landlords since its implementation. It has significantly impacted their property profits, resulting in higher tax payments. Various efforts have been made to challenge and reverse Section 24, including a notable legal challenge led by Cherie Blair.

Most recently, a petition with over 32,000 signatures has called for the reinstatement of tax relief that allows mortgage interest to be deducted from rental income. Despite these challenges and petitions, the government has maintained its stance on Section 24. In response to the petition, a government spokesperson emphasized their commitment to setting mortgage interest relief against rental income at the basic rate of tax, citing the need to ensure fairness in the income tax system.

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 landlords are now taxed on their property income before accounting for finance costs.

For example, consider Fred, a landlord who receives income A from his job annually and income B from his rental property. His total income is A+B. Fred also has mortgage costs (C) and annual property maintenance expenses (D).

Previously, his taxable income was A + (B – (C + D)). However, with Section 24 fully in effect after 2021, his taxable income is simply calculated as A + B – D.

There may be a 20% tax reduction available, as explained earlier, based on the lower of finance costs, property business profits, and adjusted total income.

How Section 24 affects landlords

Section 24 straightforwardly increases landlords’ taxable income, resulting in higher overall tax payments. This impact becomes substantial when it pushes them into a higher tax bracket.

Consider our example with landlord Fred, now with numerical values:

We’ll use the personal allowance and tax band values from the 2022/23 tax year to highlight the effects of Section 24’s financial cost restrictions.

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

A landlords’ tax example under Section 24

In this example, Section 24, fully implemented since 2021, eliminates the ability to deduct mortgage finance costs, although a 20% basic rate deduction may be applicable, as explained below.

Fred still earns £42,000 from his job and £20,000 from his rental property. For simplicity, we haven’t considered any tax already deducted from his employment income.

He pays £9,000 for his mortgage and £1,000 for maintenance, without any unused finance costs carried forward.

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 pays zero tax on the first £12,570 of his income due to his personal tax allowance (2022/23).

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

Additionally, he pays 40% tax on the final £10,731 of his income, crossing into the higher tax band applied to income over £50,270.

Finance costs (with no brought forward) are lower than property profits and adjusted net income, enabling a 20% tax reduction based on the £9,000 finance costs. This results in an additional relief of £1,800, reducing the total tax payable from £11,832.20 to £10,032.20.

Fred’s final tax bill under Section 24 is 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 must pay an additional £1,800 in tax compared to the pre-Section 24 era, despite his unchanged salary and rental income.

Furthermore, Fred now falls into a higher tax bracket, potentially impacting him as his employment income increases in the future.

The implementation of Section 24 carries additional drawbacks, including the possibility of child benefit clawback through the high-income child benefit charge if income exceeds £50,000.

These changes have proven particularly costly for landlords with just one or two properties, exemplified by Fred, as they are more susceptible to being pushed into the higher tax bracket.

Three alternative routes to Section 24

Despite concerns surrounding the introduction of Section 24, landlords are exploring three alternative routes instead of immediately selling their rental properties:

1. Partner Route

Some landlords consider transferring properties to a lower-income partner or legally structuring a partnership arrangement recognized by HMRC.
Transferring property to a partner with basic or no tax liability can significantly reduce rental income tax.
It’s essential to seek advice from an accountant before proceeding with this approach.

2. Limited Company

Another option is transferring property ownership to a limited company.
Limited companies are exempt from Section 24, allowing 100% of mortgage interest to be tax-deductible as a business expense.
The UK corporation tax rate (19%) is lower than the higher band tax rate (40%).
However, this may involve paying stamp duty and capital gains tax unless specific reliefs apply.
Extracting profits from the company can result in double taxation.
Limited company mortgages may have higher fees and interest rates than personal buy-to-let borrowing.

3. Holiday Let

Some landlords are transitioning their rental properties into holiday lets.
Furnished holiday lets are exempt from Section 24 and are treated as trading businesses.
Finance costs related to holiday lets can be offset against tax.
Holiday lets may generate higher income but require more management and may not suit every property.
Lenders may have restrictions on holiday let properties.
Legal requirements for holiday lets include availability for at least 210 days a year, with at least 105 days of letting and limited long-term accommodation.
For landlords with multiple mortgaged buy-to-let properties, securing most debt on one holiday let allows for finance cost offsetting.

Consulting with an accountant is crucial before converting a property into a holiday let, considering various tax implications and suitability.