What Landlords Need to Know About Section 24

Nikka Sulton

What Landlords Need to Know About Section 24

Understand the impact of Section 24 Tax Changes for Landlords on taxes and profits in the rental property sector. Explore the essentials, especially for those in higher tax brackets. Introduced in 2015 and fully in effect since April 2020, these changes raise concerns among landlords about their implications. Delve into the details to navigate the possibility of avoiding Section 24 tax and make informed decisions in this evolving landscape.

What is Section 24?

In 2015, the then-Chancellor George Osborne implemented a significant tax policy change known as Section 24, which had a considerable impact on buy-to-let mortgages. Under this controversial regulation, rental income from properties became fully taxable. Landlords, however, retained the ability to claim back mortgage interest costs, albeit limited to the basic income tax rate of 20 percent. The implementation of these changes was phased in, starting in 2017 and reaching full effect in April 2020.

Prior to the initiation of these tax alterations in 2017, landlords had the privilege of deducting the entirety of their mortgage interest from their rental income, resulting in taxation solely on their profits. However, during the transitional period between April 2017 and April 2020, mortgage interest tax relief underwent a gradual reduction, ultimately being replaced by a 20 percent tax credit.

What is Section 24 of Income Tax Act?

Section 24 of the Income Tax Act of 1961 deals with interest payments on home loans and is categorized as “Deductions from house property income.” This section allows for tax deductions on the interest paid on your home loan.

In the broader context of the Income Tax Act, various sections offer tax exemptions for specific investments and expenses. The government recognizes the importance of homeownership and provides multiple exemptions for investments in your first home, alleviating tax burdens.

Section 24, focusing on home loans, offers exemptions for the interest payments made on these loans.

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.

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

Section 24 phase-in

The changes related to Section 24, also known as the tenant tax, were introduced in four stages starting from April 2017, with full enforcement taking effect in April 2021. Here’s a breakdown of these stages:

2017/18 tax year: Landlords could only deduct 75% (rather than 100%) of their finance costs at the higher-rate, with the remaining 25% deducted at the basic rate.
2018/19 tax year: The deduction for finance costs at the higher-rate was reduced to 50%.
2019/20 tax year: Only 25% of finance costs were tax-deductible at the higher-rate.
2020/21 tax year: Landlords could only claim basic rate deductions, but 20% of finance charges could still be offset against tax.

Finance costs primarily include mortgage interest, although they can also encompass mortgage fees and interest on loans taken out for property furnishing or refurbishment. It’s important to note that other expenses, such as maintenance costs, remain eligible for tax offset.

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.

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.

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?”