Your guide to Section 24 and how you can manage it
Section 24 was announced in 2015 and refers to a change in tax law that affects the amount of tax relief landlords receive. The amendment was phased in gradually but came into full force in April 2020. Here, we explore how Section 24 works, how it affects landlord income and what you can do to off-set the effects.
What is Section 24? Tax relief changes explained
Section 24 is an amendment in the UK’s tax law that applies to income on residential rental properties. The legislation means that landlords cannot claim as much tax relief as they could previously.
Before Section 24 was introduced, you could deduct mortgage interest from your income tax bill. You could also deduct other costs related to rental properties, such as mortgage admin fees or loans to pay for furniture.
Now, you’ll need to pay tax on all the rental income you receive. You can then claim back mortgage interest costs but only up to 20% (the basic rate of income tax).
In effect, it means landlords now pay more tax upfront. Plus, if you also receive a salary from another job, this could bump you into the next tax band which can increase the amount of tax you pay overall.
Why was Section 24 introduced?
Section 24 tax changes were introduced with several aims in mind:
- To curb the private rental market by making it less attractive to landlords.
- To stop higher earners from claiming back large amounts of tax relief.
- To increase the level of housing stock and give first-time buyers a greater opportunity to get a foothold on the property ladder.
How does Section 24 work?
Under Section 24 rules, you’ll need to pay income tax on all earnings from property. You can then claim back relief but only up to 20%.
Here’s an illustration of how Section 24 works:
- Your rental income is £15,000.
- Your mortgage interest is £5,000.
- Under Section 24 you’ll need to pay tax on the full rental income. This is £3,000 for basic rate taxpayers (20%) and £6,000 for higher rate taxpayers (40%).
- You can then claim back 20% of your mortgage interest payments which is £1,000 (20% of £5,000).
- Therefore, basic rate taxpayers will pay £2,000 tax on their rental income and higher rate taxpayers will pay £5,000.
If you rent out a property, you’ll need to pay tax on any profit you make. While it may seem like a like a simple calculation, tax on rental income can be complex and something you should consider.
What does Section 24 mean for landlords income?
The affect of Section 24 on your income will depend on which tax band you fall into.
For lower income earners, the effect will be minimal. For landlords with large portfolios, the impact could be significant.
Let’s take the same example above but compare the results from before Section 24 was introduced:
- You can deduct your mortgage interest from your rental income so only pay tax on £10,000.
- Basic rate taxpayers pay £2,000. Higher rate taxpayers pay £4,000.
As you can see, basic rate taxpayers see no difference as you can claim back the 20% you would have deducted previously.
On the other hand, higher rate taxpayers will need to pay an extra £1,000 in tax. If you’ve got a larger portfolio with several buy-to-let mortgages to pay, the increase in tax could be considerable.
You’ll also need to remember that other costs can no longer be deducted so you’ll also have to pay tax on any mortgage admin fees.
How can landlords off-set and manage Section 24?
Section 24 tax relief changes apply to all landlords but there are ways to mitigate the effects, for example:
- Review operating costs – reducing property running costs is the quickest and simplest way to claw back money lost through higher tax. For instance, you could manage the property yourself instead of employing a management company.
- Re-mortgage – reviewing your overall mortgage costs and finding a more competitive loan can help minimise the impact of Section 24.
- Move towards a commercial portfolio – Section 24 only applies to residential property so switching your investments to commercial property can by-pass the ruling.
- Divide profits or transfer ownership – if you have a lower income partner or family member, splitting earnings or transferring properties to them can level out what you owe in tax.
- Become a limited company – Section 24 does not apply to limited companies so incorporating your portfolio means you can avoid the tax change. Before you do this, remember that limited companies are subject to capital gains tax and corporation tax, so you’ll need to weigh up the sums involved.
- Set up a Beneficial Interest Company Trust – this allows you to transfer your portfolio into a company structure so that you avoid the tax changes while maintaining personal ownership of the property. In this instance, there is also no need to re-mortgage your properties. These trusts have other implications such as corporation tax and there could also be issues with re-mortgaging in the future. If this is an option you’re interested in, it’s recommended that you seek professional advice first.
- Increase rent – this could make up for the higher tax burden but it’s a fine balancing act because you’ll need to avoid slipping into the next tax band.
- Reduce your portfolio – streamlining your investments and selling poor performing properties can reduce what you’re taxed on.
- Sell your properties – for many landlords, sadly selling up is the only viable solution, particularly if properties are located in stagnant markets.
If you decide to streamline or sell your properties altogether, a Section 21 notice can make it clear that you won’t be renewing the tenancy agreement after the contract ends.
Protect yourself from financial loss
Changes in legislation mean it’s more important than ever to protect the investments you have. It’s also crucial to ensure the services you receive give you value for money.
At Alan Boswell, we offer five star rated insurance products that provide bespoke cover for a wide range of landlord needs. To find out more about our award-winning service, take a look at what we offer in our landlords hub or contact a dedicated member of the team on 01603 216399.