Section 24 - a guide for landlords
- Announced in the Summer Budget of 2015, and introduced on 6th April 2017, Section 24 is an amendment to UK Tax Law. It means the amount of income tax relief landlords receive for residential property finance costs will be restricted to the basic rate of tax. The changes will be introduced in a phased approach with the elimination of tax relief on mortgage interest payments taking place as follows:
- Landlords currently can offset 75% of their mortgage interest vs. rental income
- From April 2018, this will fall to 50%
- In April 2019, this will fall again to 25%
- In April 2020, it will be reduced to 0% and will be replaced by tax credit of 20%, limiting the short-term impact
- Section 24 applies to:
- Landlords who are UK residents with residential rental properties, regardless of location
- Non-UK resident landlord with residential rentals based in the UK
- Partnerships and Trusts with residential rental properties
- The perceived Government objective of Section 24, otherwise known as the ‘Tenant Tax’, is to reduce the number of ‘accidental’ landlords operating in the market. Encouraging landlords to become professional property businesses is expected to improve the stability and profitability of the sector to the benefit of landlords and tenants alike.
- The revised relief will be incorporated as part of 2017 tax returns, due to be filed by 31st January 2018.
- According to figures released in March, approximately 8.2 million people in England alone will be affected by the changes
- There are concerns that a number of landlords plan to leave – or have already left – the market. According to research conducted by Simple Landlords in July:
- The elimination of tax relief is landlords biggest concern, with 25% of all landlords deeming it the no.1 market issue, including 28% of single property owners
- 47% of our customers surveyed said that the Government’s tax policy had forced them to change their investment strategy. 6% of landlords we spoke to plan to exit the market as a result of the changes.
- If landlords do exit the market, it could lead to a shortage of rental properties, which could increase rents and drive rates of homelessness higher.
- Experts say higher and additional rate taxpayers will be hit hardest by the changes
- Buy-to-let landlords in the 40-45% tax bracket will pay more tax
- Landlords in the 20% bracket could pay more if their gross income exceeds £45k. This could also impact child tax credits and student loan repayments.
- In April, the National Landlords Association estimated that in 2017 alone 440,000 landlords would be pushed into a higher tax bracket by either moving basic-rate tax payers into a higher rate tax bracket, or higher-rate tax payers moving to an advanced rate, as a result of the changes.
- The combined effect of reduced cash flow when making payments on account and new restrictions to borrowing as a result of new Prudential Regulation Authority (PRA) regulations could result in a ‘double whammy’ for landlords, which will also impact their borrowing.
The bottom line
- Tax will be calculated on rental profits after costs (including property maintenance) have been deducted. However, interest and other finance charges will be excluded from any tax savings.
- Once tax has been calculated landlords will be able to offset 20 per cent of finance charges against the tax due.
- In partnership with Tax Advantage, Simple Landlords has projected how a landlord currently paying the basic-rate of income tax could become a higher-rate taxpayer between 2017-2020.
A landlord with a annual salary of £35,000 collects £12,000 in rent annually from a property. This includes costs (£2,000) and mortgage interest (£5,000).
Total taxable income is £40,000, currently below the threshold for the higher rate in income tax.
According to the current regime, the landlord would pay tax of £1,000 on his property income annually.
In first year of the changes, a quarter of the landlord’s interest payments are taxed at the basic rate, which has no ultimate impact on his/her tax bracket. In the second year, however, with only 50% of his mortgage interest charged the basic rate, it results in paying higher-rate tax on £35 of his/her income.
By 2020/21, 100% of mortgage interest is charged at the basic rate, but 20% of it is relieved. This results in an increased tax burden of £1,507, or £507 more than in 2017/18.
Paying tax on a greater percentage of mortgage interest, combined with other sources of income, pushes the landlords into a higher tax bracket.
How to manage Section 24
There are several options for landlords to negate the impact of Section 24, which include trimming expenses in other areas, or changing the way their businesses are run – and therefore taxed. Each option will depend up on a landlord’s personal circumstances, but they include:
- Incorporate and become a limited company - which is exempt from Section 24. However, landlords should take time to consider their options, and should bear in mind that transferring properties to a limited company is likely to incur stamp duty and capital gains tax - as well as remortgage fees and early repayment penalties from lenders. And then in addition to paying corporation tax on profits, landlords will be taxed when they withdraw money from the company.
- Investing in commercial property is another means of avoiding section 24, so diversifying the portfolio as always remains a good option.
- Place the portfolio in a Beneficial Interest Company Trust This entails transferring interest, but does not require re-mortgaging. It also involves switching from income to corporation tax. However, this will incur professional fees which may prove prohibitive.
- For those in a partnership business, where one of the partners occupies the lower 20% tax rate, switch the division of profits to reduce the tax payment. Bringing an unemployed partner or spouse into the business will achieve the same benefit.
- Re-mortgaging it allows the landlord to capitalise on historically low interest rates, particularly for those with significant equity. Lower monthly repayments will offset any increased tax burden.
- Avoid the higher tax bracket. This can include making higher pension contributions or more gift donations.
- Increase Rent to offset the loss but without straying into a higher tax bracket.
- Shrink or diversify the portfolio, especially if some of the properties are underperforming. This could include adding commercial properties, which will not incur the tax relief penalties as residential properties.
- Develop a business plan This is a requirement for the new Prudential Regulation Authority (PRA) lending regulations, but in any case makes good business sense to ensure investment is being maximised and profitability managed.
- More information on the changes can be found on the Government tax website: https://www.gov.uk/government/publications/restricting-finance-cost-relief-for-individual-landlords/restricting-finance-cost-relief-for-individual-landlords