What is Section 24 for Landlords?

In recent years, the UK's property market has seen a significant shift in the taxation landscape for landlords. One of the most impactful changes has been the introduction of Section 24 of the Finance (No. 2) Act 2015. This legislation has altered how landlords are taxed on their rental income, leading to financial and strategic implications for property investors. 

In this article, we will explore what Section 24 is, how it affects landlords, provide a worked example to illustrate the changes, discuss strategies landlords can consider to mitigate its impact, explain the process and costs of moving properties into a limited company, and outline the tax implications of selling a property owned by a limited company.

Understanding Section 24

Section 24, also known as the 'Tenant Tax' or the 'Landlord Tax,' was introduced by the UK government in 2015 and came into effect gradually between April 2017 and April 2020. The key change brought about by Section 24 is the restriction on the amount of mortgage interest and other finance costs that landlords can deduct from their rental income before calculating their taxable profit.

Prior to Section 24:

Before Section 24, landlords could deduct 100% of their mortgage interest and other finance costs from their rental income. This deduction meant that landlords were only taxed on the profit remaining after these costs were subtracted, often resulting in lower tax liabilities.

After Section 24:

With the full implementation of Section 24, landlords are no longer able to deduct all their finance costs from their rental income. Instead, they now receive a tax credit based on 20% of their mortgage interest payments. This means that higher-rate taxpayers and additional-rate taxpayers are particularly affected, as they now pay tax on the full rental income and only get a basic rate deduction for their finance costs.

Impact of Section 24 on Landlords

1. Increased Tax Bills: For landlords who are higher-rate or additional-rate taxpayers, Section 24 can significantly increase the amount of tax they owe. This is because they can no longer offset their entire mortgage interest against their rental income. Instead, they are taxed on their total income, including mortgage interest, and receive only a 20% tax credit on their finance costs.

2. Reduced Profit Margins: As a result of the increased tax bills, many landlords have seen their profit margins shrink. In some cases, landlords may even find themselves in a situation where their rental income is not sufficient to cover their mortgage payments and tax liabilities.

3. Potential Push to Higher Tax Bands: The change in tax calculation means that some landlords may find themselves pushed into a higher tax bracket. Because taxable rental income is now higher, even if actual profit hasn't changed, landlords might be taxed at a higher rate.

4. Cash Flow Considerations: For landlords with highly leveraged properties, the reduced ability to deduct mortgage interest can lead to cash flow issues. This is especially true if rents are not increased to offset the higher tax burden.

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Worked Example of a Landlord’s Self-Assessment Tax Before and After Section 24

Let's go through a simplified example to illustrate how Section 24 affects a landlord’s tax calculation. We'll assume the following scenario for a landlord:

• Rental Income: £20,000 per year

• Mortgage Interest: £12,000 per year

• Other Allowable Expenses: £2,000 per year

• Landlord's Tax Band: Higher-rate taxpayer (40%)

Before Section 24

1. Calculate the Taxable Profit:

   • Rental Income: £20,000

   • Less Mortgage Interest: £12,000

   • Less Other Allowable Expenses: £2,000

   • Taxable Profit: £20,000 - £12,000 - £2,000 = £6,000

2. Calculate the Tax Owed:

   • Taxable Profit: £6,000

   • Tax Rate (40%): £6,000 * 40% = £2,400

3. Total Tax Payable: £2,400

After Section 24 (Full Implementation)

1. Calculate the Taxable Income Without Mortgage Interest Deduction:

   • Rental Income: £20,000

   • Less Other Allowable Expenses: £2,000

   • Taxable Income: £20,000 - £2,000 = £18,000

2. Calculate the Tax Owed Without Mortgage Interest Deduction:

   • Taxable Income: £18,000

   • Tax Rate (40%): £18,000 * 40% = £7,200

3. Calculate the Section 24 Tax Credit:

   • Mortgage Interest: £12,000

   • Tax Credit (20% of Mortgage Interest): £12,000 * 20% = £2,400

4. Calculate the Total Tax Payable After Applying the Tax Credit:

   • Tax Owed Before Tax Credit: £7,200

   • Less Section 24 Tax Credit: £2,400

   • Total Tax Payable: £7,200 - £2,400 = £4,800

Summary of the Example

• Before Section 24:

  • Taxable Profit: £6,000

  • Tax Payable: £2,400

• After Section 24:

  • Taxable Income: £18,000

  • Tax Owed Before Credit: £7,200

  • Tax Credit: £2,400

  • Total Tax Payable: £4,800

Impact: The tax payable has increased from £2,400 to £4,800 due to the implementation of Section 24. This doubling of the tax bill shows how significant the impact can be for higher-rate taxpayers who rely on mortgage interest deductions to reduce their taxable income.

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Who is Affected by Section 24?

Section 24 primarily affects:

• Individual landlords who own rental properties in their personal name.

• Higher-rate and additional-rate taxpayers.

• Landlords with significant mortgage interest costs.

It does not impact:

• Landlords who own properties through a limited company.

• Landlords who have little or no mortgage on their rental properties.

• Basic rate taxpayers (though they might be pushed into a higher tax band due to Section 24).

Moving Your Rental Property to a Limited Company

One of the potential strategies for mitigating the impact of Section 24 is transferring your property portfolio into a limited company. This can allow landlords to continue deducting mortgage interest as a business expense, but it's not a decision to be taken lightly, as there are several costs and implications involved.

Steps and Costs Involved

1. Incorporating a Limited Company:

   • You will need to set up a limited company if you do not already have one. This process is relatively straightforward and can be done through Companies House.

   • Cost: Setting up a company usually costs around £50 for online registration. However, there may be additional costs if using an accountant or solicitor.
     

2. Transferring the Property:

   • Transferring the property from personal ownership to the company is considered a sale, meaning it triggers both Stamp Duty Land Tax (SDLT) and potentially Capital Gains Tax (CGT).
     

3. Stamp Duty Land Tax (SDLT):

   • The company will need to pay SDLT on the market value of the property. Limited companies also pay an extra 3%.

   • Cost: This cost varies depending on the property's value but can be significant, especially for higher-value properties.
     

4. Capital Gains Tax (CGT):

   • If the property has increased in value since you purchased it, you'll need to pay CGT on the 'gain.' The rates for CGT on property are 18% for basic rate taxpayers and 24% for higher and additional rate taxpayers.

   • Cost: The CGT cost will depend on the property's increase in value and your income tax band. It’s essential to get an accurate valuation to calculate this correctly.
     

5. Mortgage Implications:

   • The mortgage must be transferred to the limited company, which is often considered a new application. Lenders typically have stricter criteria and higher interest rates for limited company mortgages.

   • Cost: Potential higher mortgage rates and arrangement fees. You may also incur early repayment charges if you are breaking a fixed-term mortgage agreement.
     

6. Ongoing Costs:

   • Corporation Tax: Limited companies pay Corporation Tax on their profits, which is currently lower than the higher rate of income tax.

   • Dividend Tax: When you withdraw profits from the company, you may pay tax on dividends, depending on your personal tax situation.

   • Accountancy Fees: Limited companies have more complex accounting and reporting requirements, so accountancy fees are usually higher.

   • Administrative Costs: Additional administrative responsibilities such as filing annual accounts, tax returns, and potentially VAT returns if applicable.
     

7. Professional Advice and Legal Costs:

   • It is crucial to seek professional advice from an accountant or tax advisor before making this decision to ensure it is financially viable and to navigate the process.

   • Cost: Professional fees vary but are an essential investment to avoid costly mistakes.

Summary of Costs

• Incorporation Fees: ~£50 (basic) + possible professional fees.

• SDLT: Based on the property’s value and the higher rate (an extra 3% if owning other properties).

• CGT: Varies depending on the gain and the individual's tax band.

• Mortgage Fees: Potential higher interest rates, arrangement fees, and early repayment charges