Section 24, often familiar to landlords, brings increased taxes, reducing profits in the residential rental property sector. Many landlords are concerned about these changes. To address whether it’s possible to avoid Section 24 tax altogether, let’s dive into the essentials of Section 24. We’ll explain how it functions and its implications for landlords.
The Government introduced section 24 tax changes in 2015, fully implementing them in April 2020. Private landlords, especially those in higher tax brackets, might be impacted.
What is Section 24?
Section 24 is a UK tax law amendment that affects income from residential rental properties. This change limits the income tax relief landlords receive for property finance expenses.
Currently, landlords can only get a 20% tax credit based on their loan and mortgage interest payments. It has also pushed some landlords into higher tax brackets, increasing their tax payments and reducing profits.
Why was Section 24 introduced?
The Section 24 tax was implemented as part of a strategy to curb the rapid growth of the private rental sector. When it was introduced, there were concerns about a potential property “bubble” forming, which could have adverse effects on the broader economy.
The primary aim of Section 24 is to reduce the profitability of buy-to-let properties, making it less attractive for landlords and potentially leading some to exit the sector. This slowdown in the market is seen as a way to address the perceived issues associated with a rapidly expanding rental market.
Additionally, Section 24 has the effect of making property “flipping” less lucrative, discouraging this practice. As a result, fewer individuals engage in flipping properties, which, in turn, increases the supply of properties on the market. This increased supply can benefit first-time buyers, making it easier for them to enter the property market.
How does Section 24 work?
Section 24 represents a significant change for landlords, as it mandates that they must pay income tax on their entire rental income, with the option to claim back a maximum of 20% in tax relief.
To illustrate how this works, consider an example: Let’s assume your rental income amounts to £15,000, and your interest payments on the property amount to £5,000.
- Firstly, you will be required to pay tax on the full rental income.
- For basic rate taxpayers (taxed at 20%), this tax would amount to £3,000. For higher rate taxpayers (taxed at 40%), the tax would be £6,000.
- You can then claim back 20% of your interest payments, which is £1,000 (as £1,000 represents 20% of £5,000).
- Consequently, basic rate taxpayers would pay a total of £2,000 in tax, while higher rate taxpayers would pay £5,000 in tax.
This example illustrates that Section 24 has a more substantial impact on higher-rate taxpayers. The intention behind this is to dissuade potential landlords from entering the private rental sector.
How Can You Avoid Section 24 on a Buy-to-Let?
Section 24 tax changes have prompted landlords to explore strategies to mitigate their impact. While it’s essential to consult with a specialist accountant before making any decisions, here are some potential options:
1. Invest in holiday lets
With rising tax obligations on buy-to-let properties, many landlords are turning to holiday lets. Furnished holiday homes are classified differently by HMRC and enjoy more favorable tax treatment. Unlike buy-to-lets, holiday lets can still deduct mortgage interest, financing, and other business expenses from their total tax costs.
For a property to qualify as a holiday let, it must meet specific conditions:
- It must be available for rent for at least 210 days a year.
- Guests must occupy it for a minimum of 105 days a year.
- Tenancies lasting longer than one month in any year should not exceed a total of 155 days (e.g., one tenancy lasting 155 days or multiple monthly tenancies exceeding 155 days).
2. Transfer your property to your partner
If you’re a higher rate taxpayer and your partner falls into the basic rate tax category, you can transfer ownership to your partner through a ‘deed of trust.’ This method diverts property income to the named person on the deed, often for tax advantages. It’s crucial to consult with a solicitor or a specialized deed of trust service provider before proceeding.
Determine how much rental income you can transfer to your partner. For example, if your partner’s total taxable income is £30,000 (placing them in the ‘basic rate’ tax band), you can transfer a property with an annual rental income (before mortgage interest) of £20,270 (going beyond this threshold pushes your partner into the higher tax bracket, starting at £50,270).
Remember, transferring property between partners can be intricate. Additionally, you may still be liable for stamp duty land tax (SDLT). Transferring between spouses can provide SDLT relief, but it becomes more complex when mortgages are involved. Seek advice from an accountant or legal professional experienced in property tax.
3. Increase the rent
Raising the rental rates on your properties can help offset the higher tax burden. However, be cautious not to overprice, as it could push you into a higher tax band. This approach has some challenges. If your rental prices are too high, you might struggle to find tenants, leading to costly void periods. To justify increased rent, you may need to invest in property improvements, raising the property’s value.
It’s essential to strike a balance between rental increases and tenant demand, ensuring your properties remain attractive and competitive in the market.
4. Re-mortgage your property portfolios
Caution is advised here, especially in the current climate of rising interest rates in the UK. Before considering remortgaging, monitor the Bank of England’s interest rate policies in 2023. If rates are lowered, remortgaging may become a more viable option.
To mitigate Section 24’s impact, review your overall mortgage costs and seek more competitive loan options. Since your initial mortgage, the mortgage market may have evolved, potentially offering better interest rates.
However, assess the following factors:
- Check fees: New mortgages may come with arrangement and product fees that could outweigh the benefits, so compare costs carefully.
- Consider your current deal: If you’re not nearing the end of your fixed or discount rate term and plan to terminate your existing mortgage early, be aware of potential early repayment charges from your current lender.
5. Incorporate into a limited company (LTD)
Section 24 does not apply to limited companies. You can establish a limited company and transfer your property rental business to it in exchange for shares. This reclassification places your property outside the scope of Section 24. However, remember that you will incur stamp duty costs when transferring the property into a limited company, even if you previously paid it during the property’s purchase.
6. Sell underperforming assets
Evaluate the returns on all your residential properties to identify underperforming ones. These properties contribute to your taxable income without offering significant value, making it advisable to sell them to reduce your taxable income.
7. Review operating costs
While not a direct method for avoiding Section 24, it’s essential to maximize rental income to offset tax effects. Traditional property management companies often impose high management and administration fees. Consider alternative management services like Flex Living, which offers 0% maintenance or management fees and 0% voids, helping you maximize rental income while reducing the burden of day-to-day property management.
Navigating Section 24 requires careful planning and consideration of these strategies to minimize its impact on your rental property investments.