Section 24: The Tenant tax

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Section 24 was announced in the Summer Budget of 2015 and introduced on 6th April 2017. It is an amendment of UK Tax Law and its comparative newness is leaving tenants and landlords alike in the dark. However, its vast impact means that it’s imperative to understand the ins and outs of this regulation.

Section 24 means that the amount of income tax relief landlords receive for residential property finance costs will be restricted to the basic rate of tax. Consequently, you will no longer be able to claim mortgage interest, or any other property finance, as tax-deductible. Instead, by 2021, rental profit will be taxed with a maximum deduction for finance costs at the basic rate of 20%.

The Aim

The perceived Government objective is to reduce the number of ‘accidental’ landlords operating in the market. By encouraging landlords to become professional property businesses, it is expected to benefit landlords and tenants alike by improving the stability and profitability of the sector.

Who Will be Affected?

If you have any kind of loan or mortgage, then this will concern you and your property. Furthermore, if you have interest in a buy-to-let property, landlords can also be affected by these changes. If these ventures are a large proportion of your costs, you will pay tax on both those costs and on your profits.

Section 24 applies to

Landlords who are UK residents with residential rental properties.
Non-UK resident landlords with residential rentals based in the UK.
Partnerships and Trusts with residential rental properties.

Landlords currently can offset 75% of their mortgage interest vs. rental income. The changes have been introduced in stages to eliminate the tax relief on mortgage interest payments in the following way:

From April 2018, tax relief fell to 50%.
In April 2019, this again fell to 25%.
In April 2020, it will be reduced to 0% and will be replaced by a basic tax credit of 20%.

Tax Calculations

When these steps have been taken, Tax will be calculated on rental profits after costs, including matters of property maintenance, have been deducted. Interest and other financial 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.

How to Minimise the Impact of Section 24

Landlords can ensure that Section 24 does not affect their livelihood so strongly through changing the way in which their business is run and therefore taxed by also trimming expenses in other areas.

These changes could prove beneficial depending upon the condition of each landlord’s circumstances, these are:

Become a limited company: Limited companies are exempt from Section 24, however, landlords should bear in mind that transferring properties to a limited company might also entail:

– Capital gains tax and stamp duty.

– Re-mortgage fees and early repayment penalties from lenders.

– Corporation tax on a landlord’s profits.

This means that the landlord will be taxed whenever they withdraw money from the company.

Placing the portfolio in a Beneficial Interest Company Trust: This would allow the landlord to move the economic value of their property by transferring interest. It does not require re-mortgaging, but it also involves switching from income to corporation tax which entails professional fees.
Partner businesses dividing profits: Where one of the partners occupies the lower 20 percent of tax rate or an unemployed partner can be brought into the business, the tax payment will be reduced.
Shrink or diversify your portfolio: This is especially important to consider if some of the properties are underperforming.
Develop a business plan: This is prudent to ensure your investment is being maximised and profitability managed. It is also a requirement for the new Prudential Regulation Authority (PRA) lending regulations.
Investing in Commercial Property: Commercial properties are also exempt from Section 24. Taking the opportunity to diversify your property portfolio is always wise and would spread the effects of such legal changes.
Avoid the higher tax bracket: This can include making higher pension contributions or more gift donations to distribute your wealth.
Re-mortgaging: This allows the landlord to benefit from any low-interest rates, particularly for those with significant equity. From this, lower monthly repayments will compensate for any increased tax burden.
Increase Rent: This will offset the loss but without straying into a higher tax bracket.

Although the new regulations could appear worrisome at first glance, there are other options that can be considered to both minimise the loss you make as a landlord and steel your resources in other areas to ensure you are prepared for the changes in the coming months. If you require legal advice, Stirling Ackroyd Legal is at hand to provide the specialist guidance