What is Section 24 of Income Tax Act?

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Section 24 of the Finance Act 2015, also known as the ‘Tenant Tax,’ poses significant challenges for today’s landlords. It imposes substantial financial burdens by altering how landlords can deduct expenses.

Section 24 removes the ability to deduct most finance-related expenses, including mortgage interest and arrangement fees, before calculating tax liability on rental income. Landlords now pay tax on their total rental income, often pushing them into higher tax brackets, potentially affecting the profitability of their portfolios.

To cope, many landlords have raised rents to offset the added tax costs, leading to the unfortunate ‘Tenant Tax’ label as tenants bear the brunt of rising rents.

What is Section 24 of Income Tax Act?

Section 24 of the Income Tax Act of 1961 deals with interest payments on home loans and is categorized as “Deductions from house property income.” This section allows for tax deductions on the interest paid on your home loan.

In the broader context of the Income Tax Act, various sections offer tax exemptions for specific investments and expenses. The government recognizes the importance of homeownership and provides multiple exemptions for investments in your first home, alleviating tax burdens.

Section 24, focusing on home loans, offers exemptions for the interest payments made on these loans.

Why is Section 24 called Section 24?

Section 24, also known as ‘S24’ or the ‘Tenant Tax,’ gets its name from the legislation that was revised to introduce the tax changes, specifically Section 24 of the Finance (No. 2) Act 2015. The term ‘S24’ is commonly used to describe this regulation, and it is often associated with the concern that both tenants and landlords will bear the financial burden of these changes.

Why does Section 24 exist?

The Government’s Claims:

Buy-To-Let (BTL) investors received financial advantages over owner-occupiers for their mortgages.
The new rules aimed to increase the availability of homes for residential buyers, particularly first-time buyers.
Reforming mortgage tax relief on BTL mortgages was intended to reduce speculation in the housing sector.
The Bank of England expressed concerns that if house prices were to drop, landlords selling properties to exit the sector or consolidate their position could worsen the decline.
The Government aims to professionalize the industry.

How does Section 24 work?

Before 2017, landlords could deduct their entire finance costs from their rental income when calculating their taxable income. However, this is no longer the case, and landlords are now taxed on their property income before considering any finance costs.

To illustrate, let’s take the example of Fred, a landlord who owns a rental property. Fred earns an annual income of A from his job and receives an annual income of B from his rental property, resulting in a total income of A+B.

However, Fred has a mortgage on his rental property, incurring annual costs of C, and he also has annual maintenance expenses of D. Prior to 2017, Fred’s total taxable income was calculated as A + (B – (C + D)).

Now, with Section 24 fully implemented after 2021, Fred’s taxable income will be calculated as A + B – D. Additionally, there may be a 20% tax reduction available, as previously described, based on the lower of the finance costs, property business profits, and adjusted total income.

When was Section 24 introduced?

Section 24, a significant piece of legislation introduced as part of the 2015 Finance Act by Prime Minister David Cameron and Chancellor George Osborne, was implemented with the aim of maintaining high levels of home ownership and curbing the rapid growth of the private rental sector (PRS). The overarching goal was to reduce demand from buy-to-let landlords and facilitate first-time buyers’ access to the property market.

This legislation was gradually phased in over four fiscal years spanning from 2017 to 2021. Year by year, a quarter of landlords’ finance costs became non-deductible, commencing at 25% in 2017-18 and reaching full implementation by 2020/21.

Concurrently, HMRC introduced a basic rate relief tax reduction during the same period. There is a minor silver lining, as landlords can still benefit from a 20% tax reduction based on the lower of the following:

Finance costs (including any carried forward finance costs from previous years).
Property business profits (after utilizing carried forward losses).
Adjusted income (income exceeding the personal allowance but after accounting for losses and reliefs, excluding dividends and savings income).

It’s important to note that this tax reduction cannot result in a repayment for the landlord. Unutilized finance costs can be carried forward for future use. For precise tax deduction calculations, it’s advisable to consult with a tax adviser.

Will Section 24 Impact my Property Business?

The positive news for those who pay the basic rate of tax is that, as long as these changes don’t push you into the higher rate tax bracket, your financial situation won’t be adversely affected (at least not immediately due to the tax adjustments). This is because you’ll continue to pay income tax at the rate of 20% and receive a 20% tax credit on your finance costs, resulting in no additional tax liability.

However, if you are already in the higher rate tax category, every pound of interest you pay will now incur an additional 20p in tax. Landlords should carefully consider this when evaluating property transactions.

Regardless of your current tax status, it’s crucial to assess how these changes will impact you. It’s not uncommon for landlords to move up the tax brackets due to Section 24. As demonstrated by an example where a landlord’s taxable profit surged by 400%, it’s even possible to transition from being a basic rate taxpayer to a higher rate taxpayer.

How Section 24 affects landlords

In straightforward terms, Section 24 results in an increase in a landlord’s taxable income, leading to a higher overall tax liability. This can have a significant impact if the additional income pushes them into a higher tax bracket.

To illustrate this, let’s revisit our example with landlord Fred, this time with specific numbers. We’ll use the personal allowance and tax band values from the 2022/23 tax year to highlight the effects of the financial cost restrictions introduced by Section 24. For context, in the 2021/22 tax year, the personal allowance stood at £12,570, and the basic rate tax band extended to £50,270.

A landlords’ tax example under Section 24

In this example, we’ll consider the impact of Section 24, which has been in full effect since 2021. This section eliminates the ability to deduct mortgage finance costs, although a 20% basic rate deduction may be available, as explained below.

Fred’s income remains at £42,000 from his job and £20,000 from his rental property. For this illustration, we haven’t factored in any tax already deducted from his employment income.

His mortgage costs are still £9,000, and maintenance expenses amount to £1,000. Fred doesn’t have any unused finance costs carried forward.

Now, his taxable income is calculated by adding his salary to his rental income and deducting ONLY his maintenance costs, as mortgage finance costs are no longer deductible. (£20,000 – £1,000 = £19,000) + £42,000 = £61,000.

Fred will pay no tax on the first £12,570 of his income, falling under his personal tax allowance (2022/23).

He’ll pay 20% tax on the next £37,699, which falls within the basic 20% tax band.

Finally, he’ll pay 40% tax on the final £10,731 of his income, as it exceeds £50,270 and enters the higher tax band.

Since the finance costs (without carry-forwards) are lower than property profits and adjusted net income, a 20% tax reduction is applied to the finance costs of £9,000. This results in an additional relief of £1,800 deducted from the total tax payable of £11,832.20.

Fred’s final tax bill under Section 24 now appears as follows:

– £61,000 Gross income

Tax Calculation:

£12,570 @ 0% (falls under Personal Tax Allowance)
£37,699 @ 20% Basic rate tax = £7,539.80
£10,731 @ 40% Higher rate tax = £4,292.40

Total tax payable = £11,832.20

Less relief for finance costs £9,000 @ 20% = £1,800

Final tax payable = £10,032.20

The outcome is that Fred now has to pay £1,800 more in tax compared to what he would have paid before Section 24 was introduced. This is despite the fact that Fred’s salary and rental income have remained unchanged.

Additionally, due to the introduction of Section 24, Fred finds himself in a higher tax bracket, which could have more significant implications as his employment income increases in the future.

The implementation of Section 24 can also bring other drawbacks, including the potential clawback of child benefit under the high-income child benefit charge if income exceeds £50,000.

These changes have been particularly costly for landlords with just one or two properties, like our example, Fred. They are more likely to be pushed into the higher rate tax bracket, making the impact even more pronounced.

What counts as ‘Finance Costs’ in Section 24?

To clarify how Section 24 affects residential landlords, ‘Finance costs’ encompass:

Mortgage interest
Interest on loans for furnishings
Fees associated with mortgage or loan acquisition or repayment

It’s important to note that tax relief typically doesn’t apply to capital repayments of a mortgage or loan, and the tax credit only pertains to the recently disallowed finance costs, not capital repayments.

Will Section 24 ever be repealed?

The possibility of repealing Section 24 exists, as it has been reversed in other countries. For instance, Ireland had similar measures in place from 2009 but began extending relief to landlords again from 2017. In Ireland, the deductibility of interest on residential mortgages increased back to 100% after a series of increments:

Prior to 2017, 75% of the interest
In 2017, 80% of the interest
In 2018, 85% of the interest
From January 2019, 100% of the interest

While the repeal of Section 24 may occur in the future, it’s unlikely to happen during the current government term. You can find more insights on this topic in an interview with LT4L Co-Founder and Group Director Chris Bailey on Property Tribes: “Are HMRC Finished with Landlords?” – Interview with Chris Bailey.