Everybody is talking about the impact of section 24. Is it another tax change? Section 24 tax change will not make a difference to the landlords with no mortgage. However, other landlords are likely to see a big rise in their tax bill and a big hit to their profits. Those in the higher rate tax bracket of 40% will receive the hardest hit.
Section 24 was introduced in April 2017 and has been phasing in over the last few years. What it means is that you will no longer be able to claim mortgage interest. No other property finance will be tax-deductible either. Instead, rental profit will be taxed with a maximum deduction for finance costs of 20%, the basic tax rate, by 2021.
The full name of the act is Section 24 of the Finance (no. 2) Act 2015, also known as the Tenant Tax because of the legal case launched to challenge the act.
Will Section 24 actually affect me?
If you have any loans or mortgage interest on your buy-to-let property, then yes. If it is a large proportion of your costs, you will now start to pay tax on those costs – as well as your profit. We strongly advise assessing your buy-to-let finances or contact a tax specialist for advice.
What can I do to limit the effects on my profit?
First step is planning forward. Speak to an accountant or a tax expert who can explain how much higher your tax bill will be and if there are any ways to minimize it. A few options include transferring property ownership into a spouse or partner’s name if they are in a lower tax threshold, setting up a company to own your buy-to-let properties and looking at your accounts to see where you can cut costs.
Are there any other changes that might affect my profits?
Along with mortgage interest relief restriction, mortgage arrangement and broker fees will no longer be tax-deductible. From April 2016, the wear and tear allowance for all landlords was scrapped. Previously, if a property was rented furnished, HMRC would allow you to offset 10% against your net income each year, regardless of whether you replaced any items. Now, this will only be allowed if you actually replace furniture like-for-like, so be wary of only replacing furniture if it’s necessary.
Changes to tax-deductible costs
From April 6th, 2017, the higher-rate tax relief can still be claimed on the first 75% of your mortgage interest costs. The remaining 25% will attract the basic rate of tax relief.
From April 6th, 2018, the amount of tax relief you can claim at the higher rates will drop to 50% of your mortgage interest costs. The remaining 50% will have the basic rate of tax relief applied.
From April 6th, 2019, the higher-rate tax relief will only apply to 25% of your mortgage interest costs. The remaining 75% will be at the basic rate.
By April 2021, you will only be able to claim tax relief at the basic rate level of 20%.
For landlords that are affected by the tax changes but have not made any changes about it, there is still time to look at ways of reducing your costs and increasing your revenue.
How to ‘spring clean’ your rental portfolio
There are clever ways in which you can ‘spring clean’ your rental portfolio to improve it. If you haven’t already, you should book a consultation with an independent financial advisor or tax specialist. They will be able to advise you on whether you need to sell off some low-yielding property, reduce some of your mortgage payments, or change the ownership of your portfolio to protect the profitability of your business. Options include setting up a company to buy a property. Or, if you already own a rental property as a private individual, you could transfer it to a limited company. However, you might need to pay capital gains tax on the difference between the original purchase price and its current value and pay stamp duty. If you’re a higher rate or additional rate taxpayer, or these changes risk tipping you into the higher tax bracket, and you own the property with a lower rate taxpayer, you can transfer more of the rent to them to limit your overall tax bill. However, changing the split could have implications on other taxes, such as capital gains tax and inheritance tax. So you should take advice beforehand.
Lower profits for landlords
Higher tax will mean lower profits for many landlords. And because of this, we can expect to see rent increases. However, rent rises are likely to be deeply unpopular with tenants. So you should think about adding some cost-effective, tax-deductible improvements to your properties that justify asking for an increase.
“The government has persistently targeted landlords with tax changes and more red tape over recent years. Rental yields continue to be stressed with tax changes over the years. Section 24 FA 2015 now found within tax legislation at Section 272A Income Tax (Trading and Other Income) Act “ITTOIA” 2005 provides for the mortgage interest restriction to take effect over the course of 3 years commencing 6 April 2017 with the full effect taking place on 6 April 2020, so the law already provides for the changes to take place.
Landlords with highly-geared portfolios might end up having to pay tax when they haven’t made a profit. For example, a 40%/45% taxpayer receiving £10,000 of rental income and paying £10,000 in mortgage interest (thus making no real profit), will pay £2,000/£2,500 in tax (2020/21).