As a landlord in the UK, you’ve probably come across the term Section 24. Introduced as part of the Finance (No. 2) Act 2015, Section 24 represents a significant shift in how landlords are taxed on their rental income, particularly concerning mortgage interest relief.
This legislation has profoundly impacted buy-to-let landlords, particularly those relying heavily on mortgage financing. Understanding the details of this tax change is crucial for anyone in property investment, as it affects profitability and the overall financial management of rental portfolios.
In this article, I’ll discuss the key aspects of Section 24, how it affects landlords, and strategies for mitigating its impact.
Understanding Section 24
Section 24 is a tax change that removes the ability of landlords to fully deduct mortgage interest and other finance costs from their rental income before calculating their tax liability. Instead, landlords now receive a tax credit equivalent to 20% of their mortgage interest payments, significantly altering how rental profits are taxed.
Prior to Section 24, landlords could subtract mortgage interest from their rental income, reducing the amount of taxable profit. This was particularly beneficial for higher-rate taxpayers, allowing them to offset large portions of their rental income against finance costs. However, the introduction of Section 24 phased out this relief between 2017 and 2020, culminating in the full implementation of the new system in 2020. Now, only a basic rate reduction is available.
Before and Under Section 24
Here’s a detailed comparison of a landlord’s tax liability before and under Section 24, illustrating how the new tax rules affect rental income taxation:
Scenario:
- Rental income: £20,000 per year
- Mortgage interest: £10,000 per year
- Other allowable expenses: £2,000 per year
- Taxpayer’s income tax rate: 40% (higher-rate taxpayer)
1. Before Section 24
Prior to Section 24, landlords could fully deduct mortgage interest from their rental income before calculating the taxable profit, lowering the amount of income subject to tax.
Calculation:
- Rental income: £20,000
- Less mortgage interest: £10,000
- Less other allowable expenses: £2,000
- Taxable rental income: £8,000
- Tax due at 40%: £8,000 × 40% = £3,200
Final Tax Liability: £3,200
The landlord’s tax bill is based on £8,000 of taxable rental income after deducting mortgage interest and other allowable expenses.
2. Under Section 24
Under Section 24, landlords can no longer fully deduct mortgage interest from their rental income. Instead, they receive a 20% tax credit on the mortgage interest, which is applied after calculating tax on the full rental income.
Calculation:
- Rental income: £20,000
- No deduction for mortgage interest
- Less other allowable expenses: £2,000
- Taxable rental income: £18,000
- Tax due at 40%: £18,000 × 40% = £7,200
At this stage, the landlord’s tax bill is £7,200, but they receive a tax credit based on 20% of the mortgage interest:
- Tax credit: £10,000 × 20% = £2,000
- Final tax payable: £7,200 − £2,000 = £5,200
Final Tax Liability: £5,200
Comparison:
- Before Section 24: Tax liability = £3,200
- Under Section 24: Tax liability = £5,200
Outcome:
Even with the tax credit applied, the landlord’s tax liability increased by £2,000 under Section 24. This example highlights how higher-rate taxpayers with significant mortgage interest are particularly affected, as their tax bill rises significantly despite the mortgage interest tax credit.
How Section 24 Affects Landlords?
The shift in mortgage interest tax relief has particularly affected buy-to-let landlords with significant mortgages. Under the old system, the more mortgage debt you had, the more you could offset against your rental income, reducing your tax bill. With Section 24 in place, that advantage is diminished, especially for higher-rate and additional-rate taxpayers.
Let’s take an example to illustrate the impact:
Before Section 24
- Rental income: £20,000
- Mortgage interest: £10,000
- Taxable income: £10,000
- Tax at 40%: £4,000
After Section 24
- Rental income: £20,000
- No mortgage interest deduction
- Taxable income: £20,000
- Tax at 40%: £8,000
- Tax credit (20% of £10,000 mortgage interest): £2,000
- Final tax payable: £6,000
As you can see, even though the tax credit is applied, the overall tax liability is higher under Section 24, leaving landlords with less net income.
Who Is Affected by Section 24?
Section 24 affects private landlords who own properties in their personal names most. This legislation doesn’t impact corporate landlords, meaning landlords who operate their rental properties through a limited company can still deduct finance costs before calculating their taxable profit.
Also, landlords with larger property portfolios or highly leveraged properties (i.e., properties with large mortgage debt) are more vulnerable to the increased tax burden. If you’re a higher-rate taxpayer with multiple buy-to-let properties, Section 24 can significantly reduce your rental profits.
It’s worth noting that if you’re a basic-rate taxpayer, the immediate effects may not seem as drastic, but if your rental income pushes you into the higher-rate tax band, you may face increased liabilities.
What Are the Strategies to Mitigate Section 24 Impact?
For many landlords, the changes brought by Section 24 have forced a reassessment of their property portfolios. Fortunately, there are several strategies you can adopt to mitigate the impact:
1. Incorporating Your Rental Business
Setting up a limited company to hold your rental properties can shield you from the effects of Section 24, as corporations are still allowed to deduct mortgage interest as a business expense. However, this approach has its own complexities, including higher administrative costs, potential capital gains tax (CGT) when transferring properties, and stricter lending criteria.
2. Reducing Taxable Income
Landlords can also reduce their taxable rental income by maximizing allowable expenses. This could include property repairs, letting agent fees, and management costs. Ensuring you claim all available deductions is essential to managing your tax bill.
3. Portfolio Restructuring
Some landlords have opted to sell off highly leveraged properties, particularly those with a high mortgage relative to rental income. By reducing debt levels, landlords can decrease rental income exposure to higher tax rates.
4. Seeking Professional Advice
The complexity of tax legislation means it’s worth consulting with a property tax specialist. They can help you navigate the changes, determine whether incorporating your property business is right, and offer tailored strategies to minimize your tax burden.
Section 24 Phased Rollout and What’s Next
Section 24 was phased in over four years, beginning in April 2017. The transitional period ended in 2020, when the full restrictions came into force. As of 2024, Section 24 remains in effect, and the government has made no significant announcements to reverse or amend this legislation.
With the upcoming general election and potential economic changes, some industry experts speculate that property taxation could be further tweaked in the future. However, landlords must now operate under the current rules and plan accordingly.
Is Section 24 Here to Stay?
There has been growing pressure from landlord groups and property professionals to repeal or amend Section 24. Many argue that the tax changes unfairly penalize landlords, particularly those providing much-needed housing in the private rental sector.
The economic environment also plays a crucial role in the ongoing debate. Rising interest rates, inflation, and a cooling property market could prompt future governments to revisit property tax legislation. However, as it stands, Section 24 remains a fundamental aspect of the UK’s approach to taxing rental income.
What are the Alternative Options for Section 24?
Landlords can explore several alternative routes to mitigate or avoid the impact of Section 24. These strategies focus on adjusting how property investments are structured or managed to optimize tax efficiency. Below are the most common approaches landlords have taken to minimize their tax liabilities under Section 24:
1. Incorporating the Rental Business
One of the most popular alternatives is setting up a limited company to hold rental properties. Corporations are not affected by Section 24, which means landlords can still deduct mortgage interest and other finance costs as business expenses, reducing the taxable profit.
- Advantages:
- Full mortgage interest relief remains available for properties held within a company.
- Corporate tax rates (currently 19%) are generally lower than higher-rate personal income tax.
- It can be more tax-efficient when growing a property portfolio.
- Disadvantages:
- Transferring personally held properties into a limited company may incur capital gains tax (CGT) and stamp duty.
- More complex administrative requirements and potential costs for setting up and running a company.
- Limited access to mortgage options, with some lenders offering fewer products to limited companies.
2. Increasing Allowable Expenses
Landlords can reduce their taxable rental income by maximizing allowable expenses. These costs are legitimately incurred in the running of a rental property and can be deducted from the rental income before calculating tax.
- Examples of allowable expenses include:
- Maintenance and repairs
- Letting agent fees
- Legal and accountancy fees
- Insurance premiums
- Utility bills paid by the landlord
- Marketing costs
By keeping thorough records of all these expenses, landlords can lower their taxable income and thereby reduce the tax payable under Section 24.
3. Moving Properties to a Spouse or Partner
If one partner or spouse is in a lower-income tax band, transferring ownership of the rental property to them could result in a lower tax liability. Married couples or civil partners often use this strategy to take advantage of the basic-rate tax band.
- Advantages:
- Tax savings if the partner receiving the rental income is in the basic-rate tax bracket.
- Still allows the couple to benefit from the rental income without the high tax burden.
- Disadvantages:
- Transfers must be handled carefully to avoid unexpected tax implications such as CGT or stamp duty.
- The partner receiving the property must be comfortable taking on the legal ownership and any associated liabilities.
4. Paying Down Mortgage Debt
Another approach is to reduce the mortgage debt on rental properties. As Section 24 mainly impacts landlords with large mortgage debts, decreasing the loan size can reduce the exposure to the new tax rules. This strategy involves paying down part or all of the mortgage, so less interest is incurred.
- Advantages:
- Reduces the taxable rental income since there’s less mortgage interest involved.
- Improves the overall profitability of the property by reducing interest payments.
- Disadvantages:
- Ties up capital that could potentially be invested elsewhere.
- For landlords with multiple properties, this may not be practical or achievable without selling off some assets.
5. Selling Highly Leveraged Properties
For landlords with multiple properties, selling highly leveraged properties (those with large mortgages compared to their rental income) may be a way to reduce their tax exposure. This approach allows landlords to focus on properties with smaller or no mortgages, which will be less affected by Section 24.
- Advantages:
- Simplifies the portfolio and reduces overall debt.
- Reduces tax liability by focusing on more profitable properties with lower finance costs.
- Disadvantages:
- Could trigger capital gains tax on any profit from the sale.
- Loss of future rental income and potential long-term capital appreciation of the sold properties.
Key Takeaways for Landlords
For UK landlords, Section 24 represents a substantial shift in taxing property income. The removal of full mortgage interest relief has increased the tax burden, particularly for those with larger portfolios and higher borrowing levels.
As a result, it’s important to review your property investment strategy, consider options like incorporation or restructuring, and consult with a tax professional to stay ahead of the changes.
Conclusion
Section 24 has undoubtedly transformed the landscape for UK landlords. While it may seem daunting, understanding the new tax rules and adapting your strategy accordingly can help you navigate the challenges.
Landlords have options to mitigate the effects of this tax reform, whether through incorporation, expense management, or portfolio restructuring. As always, staying informed and seeking expert advice is key to making sound decisions in a complex and evolving property market.
What Are the FAQs About Section 24?
How does Section 24 affect mortgage interest relief?
Section 24 restricts the amount of mortgage interest relief that landlords can claim. Instead of deducting mortgage interest from rental income, landlords now receive a 20% tax credit on their interest payments.
Are all landlords impacted by Section 24?
No, Section 24 primarily affects private landlords. Landlords who hold properties in a limited company are exempt from these changes.
Can I avoid Section 24 by incorporating my rental business?
Yes, landlords who incorporate their rental businesses can continue to deduct mortgage interest as a business expense, but incorporation comes with its own challenges, including higher administrative costs and potential CGT.
How can landlords reduce their tax liability under Section 24?
Landlords can reduce taxable income by maximizing allowable expenses or restructuring their property portfolios. Consulting with a tax advisor is recommended.
Is Section 24 the same across all UK regions?
Yes, Section 24 applies uniformly across all regions of the UK, impacting landlords nationwide.
What other property taxes should landlords be aware of in 2024?
Landlords should also be aware of stamp duty, capital gains tax, and inheritance tax, all of which can affect property investments.
What will happen to Section 24 if tax laws change in the future?
While there’s no indication of immediate changes, future governments could revisit Section 24, particularly in light of broader economic and housing market shifts.
