What Is Section 24? A Landlord’s GuideWritten By PropertyLoop May 27, 2021
Initially announced during the 2015 summer budget, going on to be implemented in April 2017, Section 24 has brought with it a change in the amount of tax landlords are required to pay. Also referred to as the “Tenant Tax”, rental property owners faced with section 24 will be prevented from making specific deductions from their tax liability, potentially pushing many into higher tax brackets, forcing costs to be recouped elsewhere; with some arguing corners will need to be cut to keep landlords out of the red. When the plans were revealed the UK government hailed the move as an initiative to combat the potential impact a housing bubble would have on the wider economy, by making it increasingly difficult for larger profits to be realised by landlords that rent out buy to let properties. The implementation of section 24 was also intended to incentive first time buyers into making their initial steps onto the property ladder, whilst making existing tenancies more stable as “flipping” properties would no longer present landlords with the same returns.
What Does Section 24 Mean?
The amount of relief landlord’s receive on their tax has in effect been reduced, meaning that thousands of landlords will end up paying a far higher amount of tax that they have in the past, due to these measures. The move by the UK government prevents rental property owners from making deductions that are related to their buy to let mortgage repayments, interest fees, costs or charges they would incur for ending a mortgage early and interest on loans taken out to help renovate or conduct remedial work on the property, when calculating their annual exposure to tax.
Whilst the government has periodically reduced the amount of mortgage interest a landlord can be granted tax relief on, seeing the amount property owners are able to offset drastically fall from 75% in 2017, to a mere 25% in 2019, only to be superseded by a 20% allowance tax credit system. Naturally this will have the largest impact on rental property owners that are placed in the higher rate band of tax payers, as they have essentially seen their tax relief be cut in half over recent years.
Prior to this landlords would have only been expected to pay income tax on the amount of rental income, or profit they realised over the preceding year. This allowed for landlords to make a larger series of deductions from the amount of tax they would be liable to pay, including their regular interest repayments on their buy to let mortgage. In effect, the now out-dated system would almost nullify mortgage payments for the landlord as many exclusively pay the interest due on the borrowed amount.
What Does the Tax Credit Mean for Landlords?
These new changes to the amount of income tax a landlords will be exposed to paying has been met with fierce criticism by rental property owners, claiming the diminished tax relief will leave them will far slimmer margins in which to operate their business and ultimately derive an suitable income.
Not only will many property owners that are a higher or additional rate tax payer have to pay for an additional 20% of their mortgage repayments, but in being forced to declare the rental income used to fund these repayments, the additional revenue could push landlords into an even higher tax bracket, only exacerbating their financial situation. Unfortunately for some, this will most certainly be the case if the owner of the rental property has maintained a secondary salary, or pension.
Who Does Section 24 Apply To?
All landlords that are currently bringing in a rental income and taking on expenses for their property portfolio will be affected by the changes established by section 24. This will encompass landlord property businesses operated by a single landlord, accidental landlord and those operating in a partnership.
With this being said, if the landlord conducted their rental business through a company they will not have to adhere to these new regulations, potentially explaining the radical shift in the amount of landlords that incorporated in the past year.
How Do You Get Around Section 24?
Whilst there are a number of changes that a landlord can implement in order to better navigate the repercussions of section 24, these measures could, if not carefully implemented, be detrimental to the landlord. In efforts to recoup income that is now contributing towards higher tax payment, common resolutions for landlords include charging tenants a higher rental price or altering the portfolio; however it is essential for landlords to avoid being placed in a higher tax bracket. If a rental property owner’s income increases through these efforts the higher tax bracket could make any changes redundant, simply increasing the amount of tax the owner of the rental will be expected to pay.
This is not to say that all efforts will yield little to no results. To help with their tax liability landlords do not have to take drastic measures and radically alter the dynamic and structure of their business or portfolio. Simply assessing the running costs of your rental property business and seeing if there any unnecessary or excessive costs incurred that could be removed from your annual expenditure.
To this end, some landlords have even taken the seeming drastic measure of selling off large portions of their portfolio. Whilst we aren’t recommending that all landlords run for the hills, putting the properties that provide you with the lowest rental return on the market could tip the balance in your favour, as these additions to your portfolio will only cost more in the long run.
Additionally, thanks to some of the lowest interest rates seen in recent history, landlords are able to use this to their advantage when assessing he market. Whilst rental property owners may no longer be able to offset the amounts they pay towards the interest on their buy to let mortgage, it is certainly within their power to reduce the rate of this interest. Landlords choosing to reportage their rental properties now could take advantage of this, helping them to somewhat mitigate their increased exposure to their annual tax.
Should Landlords Incorporate?
As mentioned the regulations of Section 24 will only apply to individual landlords, causing many to respond through incorporation. Simply put, this means that the landlord has registered their entire property portfolio under their new company, allowing them to enjoy lower rates of income tax.
However, whilst this is recommended for landlords that have an extensive property portfolio, this too can bring with it a host of complications as each property would have to be “sold” to the new company by the landlord, leaving them liable to pay capital gains tax and stamp duty on the sale of each property.
For each property that is sold to the newly established company capital gains tax must be paid. The due amount is paid on the change in market value the property has demonstrated since it was purchased. Basic rate tax payers can expect to be charged a fee of 18% on the change in market value, with those subject to a higher rate being required to pay 28% on the appreciation of the rental’s value. Of course, landlords are able to deduct a capital gains tax free allowance of £12,300, but whilst welcome this allowance could make little impact when paying multiple rates on a sizeable portfolio.
As can also be expected, when moving a substantial amount of rental properties to the business, landlords will have to incur a significant stamp duty charge. The company will be liable to pay a rate comparable to that of an individual landlord’s second rental property purchase.
It is also essential that landlords consider their buy to let mortgage before transferring their portfolio over to an incorporated company. In most cases this is certainly easier said than done as this would require the landlords to pay off their current mortgage whilst then re-mortgaging the same rental opportunity under the company.
Whilst this may seem like somewhat of a kneejerk reaction from property owners to increase the costs that come with renting their opportunities to compensate for the additional costs they will have to incur. However, it is important for landlords to note that whilst this may certainly look good on paper, it is a thin line to walk. Perhaps most obviously, increasing the amount of rent that you wish to charge tenants to let out your property could deter a large amount of interested parties. Remember, there are a number of high upfront costs that tenants are charged before they move into a rental property. With a holding and security deposit, rent in advance and potential furnishings to fork out for, a tenant’s rental journey can be a significant financial undertaking, and after all if your property is vacant, there is no one to pay the rent.
Landlords can also gain a fantastic insight into demand for rental accommodation and the average price paid for rental properties by assessing similar opportunities in the surrounding area. If there is a host of properties that offer their occupants similar or better amenities, whilst demanding a lower price from tenants then you may need to realign your rental charge. With this being said if there is a significant demand for rental accommodation in your area, you can afford to increase your rent whilst staying competitive.
Deductions Landlords Can Make From Their Tax
As can be expected, if a landlord want to minimise their exposure to tax they should make any possible deductions they can claim for, drastically reducing the figure they are required to pay. As mentioned this can no longer include contributions towards the interest on a buy to let mortgage, or any fees incurred through establishing or ending the mortgage term early. However, most other costs that a landlord would incur exclusively and wholly through their letting business can be deducted. This allows for landlords to claim for property management services such as accountants, online or high street letting agents, legal fees when evicting a tenant or seeking to reclaim possession of the property and pursuing rent arrears. Additionally with a great deal of a landlord work requiring them to commute between rental properties’, whether this is to meet tenants, process documentation, conduct property viewings or to inspect their rental; the cost associated of all this traveling can be deducted from a landlord’s tax obligations as this is deemed to be a business expense. Similarly landlords are able to make further deductions for any repair or remedial work that has been carried out on the rental property. But, with this being said it is essential that the landlord distinguish between repair work and making substantial improvements to the property, as any changes that would contribute to an increase in the rental’s market value cannot be claimed for if deemed unnecessary. Whilst this is often seen to be the responsibility of the tenants and as such is commonly stated in the tenancy agreement, but if a landlord is liable for the payment of gas, electric and ware, these utilities can also be claimed for.
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