There is a lot of confusion among landlords about Section 24, also known as the ‘Tenant Tax’. In this article, we’ll explain what you need to know about Section 24 to keep you up to date.
The government introduced Section 24 of the Finance Act 2015 in April 2017. In simple terms, Section 24 removes a landlord’s right to deduct mortgage interest and other finance costs (such as mortgage arrangement fees) from their rental income before calculating their tax liability. For the 2020/2021 tax year and beyond, landlords will only be able to claim a tax credit of 20% based on their loan and mortgage interest.
The introduction of Section 24 is a huge change because it will put some landlords into a higher tax bracket. Landlords with significant mortgage commitments could even end up paying more tax on minimal profits, pushing them into the red.
Why did the Government Introduce Section 24?
Section 24 is part of a wider set of measures designed to slow down the growth of the private rental sector. In 2015 chancellor George Osborne introduced Section 24 due to fears of a property bubble developing. If this bubble had burst, it would have caused huge damage to the wider economy. By making it harder for landlords to profit on buy to let properties, it would remove some of the less professional landlords from the sector and slow the market down. This would boost stability for tenants and make it easier for first-time buyers to gain a foothold on the property ladder. It would also make flipping less profitable, leaving more properties available for purchase.
Of course, experts disagreed with this sentiment. They warned that landlords would have to hike rents to cover the inevitable fall in rental yields and many landlords would end up making a loss. The landlords that were willing to continue would have no choice but to try different business models such as converting larger family homes into HMOs and flats to boost yields.
Who is Affected by Section 24?
Any landlords incurring finance costs are affected by Section 24. This includes so-called accidental landlords, landlords running a property business as an individual, in a partnership, or through a property trust. Non-UK resident landlords with residential properties in the UK are also affected.
Landlords who operate their property rental business through a company in the UK or outside the UK are unaffected by Section 24. Landlords with furnished holiday lets are also outside the remit of Section 24. For now, at least.
Which Costs can no Longer be Claimed Under Section 24?
Mortgage interest is the main cost that can no longer be claimed, but there are others, including:
- mortgage arrangement fees
- penalties associated with settling a mortgage early
- interest payable on loans taken out to renovate or refurnish a property
How Does Section 24 Work?
Under Section 24 rules, landlords can no longer off-set finance costs against their gross profit when tax liability is calculated. This means they pay more tax. So, if a landlord is on the threshold of a higher tax bracket, the loss of this tax relief could push them into the next tax band.
An increase in gross income may also impact child benefit, child tax credits, and student loan repayments.
Is the Introduction of Section 24 Already Having an Effect?
The private rental market has slowed down recently, surveys show that many smaller landlords have either left the PRS or are considering doing so. Data from Savills Estate Agent published at the end of last year revealed that more than 100k landlords have left the sector since 2017.
Of those who remain, there has been an increase in the number of properties being run through limited companies, which are unaffected by the new rules.
How to Off-set Section 24
There are several ways to eliminate or reduce the impact of Section 24.
Sell up and leave the sector
This might be an option if you are an accidental landlord or you are ready to quit for other reasons. Nobody would blame you, of course, but bear in mind it could take a while to sell your properties. The property market is still in a depression, and house prices are stagnant in many areas.
Let’s also not forget the human cost of such a move. You may have to evict any tenants currently living in your properties unless you plan to sell with tenants in situ. Either way it is an upheaval for both you and your tenants.
Reduce your portfolio
If leaving the sector isn’t on the cards, consider whether selling your least profitable properties is a good idea. There’s no point keeping properties that are costing you money in the long-term.
Increase property rents
Work out how much extra tax you will pay at year-end and increase the rents on your properties to offset the bill. Be careful not to price yourself out of the local market, an empty property is a huge drain on your finances.
If rent hikes are the only solution, it might be worth carrying out some improvements to your properties, to justify the rent increase.
Limited companies are exempt from Section 24, so one way to beat the system is to move your portfolio into a limited company. However, this has repercussions in other areas, in particular, Stamp Duty Land Tax and Capital Gains tax. You may also be hit with early repayment charges from your mortgage lender. Speak to an accountant before you go down this path.
Transfer your properties to a lower-income spouse/partner
Transferring ownership of rental properties might be advantageous for landlords in a higher tax bracket (or likely to be with the loss of tax relief on property finance). If a spouse or partner pays basic rate tax or no tax at all, this can reduce the amount of tax payable on rental income. Don’t do this without seeking advice from an accountant, and of course, make sure you trust the person you’re transferring it to.
Change the division of profits in a partnership
Landlord partnerships should look at their division of profits to offset the extra tax. Transfer a greater percentage of profits to a partner in a lower tax bracket or bring in a lower tax paying spouse or another relative as a business partner.
Switch to commercial properties
Commercial rental properties are exempt from Section 24. This makes them an attractive proposition for landlords. Retail units are an obvious choice, but there are many others worth considering, such as offices, warehouses, and self-storage units.
Even if you don’t want to completely overhaul your business model, diversifying some of your portfolio is not a bad idea.
Reduce your property finance costs
Mortgage interest rates are historically low right now, but there is no guarantee they will stay that way. Look for the cheapest mortgage deal possible and if you have property loans, find cheaper finance. The less interest you’re paying on your finance, the less out of pocket you will be at year end.
Cut costs elsewhere
How often do you review your business operating costs? Take a good, hard look at your costs and see if there are any areas where you can reduce your annual expenditure. We’ve already mentioned finance costs, but don’t forget, if you can save money in other areas, such as insurance or property management fees, this will save you money overall.
Go over your business plan with a magnifying glass. Remember, every little helps!
Be Careful not to Fall into a Higher Tax Bracket
With any changes you make, such as increasing rents or modifying your portfolio, be very careful not to inadvertently fall into a higher tax bracket. There’s no point paying more tax for no good reason. If in doubt, run the figures by or talk to an experienced accountant. There may be areas where you can save money that you hadn’t considered.