Thanks to the Great Buy-to-let Bashing, mortgage interest payments – a legitimate cost of doing business – are no longer tax deductible. The innocuous-sounding “Section 24” tax rule was billed as a way to give first-time buyers a leg up against investors.
(In 2015, the then Chancellor also slapped an extra 3% on stamp duty on all buy-to- let purchases. These two changes would explain a reported spike in landlords buying dartboards sporting George Osborne’s face.)
What is Section 24?
So what does Section 24 mean? From April 2020, you can no longer deduct mortgage interest as an expense before you work out your profit. Instead, you apply a 20% relief after you’ve arrived at your profit but before you calculate your tax.
It took us (and most pundits) a few days to get our heads around it. In a nutshell, it means:
- Most 20% basic-rate taxpayers end up the same
- Everyone else pays more. Worse, 40% higher-rate payers with big mortgages can end up paying more in tax than they actually make. Yes, really
- Taxable profits are higher for all, because you can’t deduct interest before you arrive at them. This could push 20% basic-rate payers on to the borderline of the 40% higher-rate band – even if they are barely profitable.
An example makes this clearer:
£11,000 rental income
[£7,500 mortgage interest not deducted] – £1,000 other costs
= £10,000 taxable profit
Allowance: 20% of £7,500 interest = £1,500 relief
20% tax on £10,000 profit = £2,000
Allowance applied: £2,000 – £1,500 relief = £500 tax
You have left in your pocket: £10,000 profit – £7,500 interest – £500 tax = £2,000
40% tax on £10,000 profit = £4,000
Allowance applied: £4,000 – £1,500 relief = £2,500 tax
You have left in your pocket: £10,000 profit – £7,500 interest – 2,500 tax = £0
If the interest were any higher, this higher-rate taxpayer would pay more in tax
than she would have left over.
The new method is being phased in over four years from April 2017. Good luck on working out your tax in the meantime – it’s not for the faint of heart (or head).
Is it the end of buy-to-let?
Since Section 24 was announced, surveys by landlord associations showed one in five planned to sell. Is it really that bad? Yes, it’s getting harder to make a profit after tax. And yes, if you’re a higher-rate taxpayer with a big mortgage, it could get impossible. Yet Armageddon it is not.
Before you panic and put your property up for sale, you need to do the maths (or get an expert to help) to see how the changes will affect your bottom line. Elsewhere we offer general tips on how to deal with Section 24:
- Should you set up a company?
- Five strategies for dealing with Section 24
- Five simple ways to be tax-efficient
- Seven ways to respond to Section 24
However, this is not tax advice. Don’t base your plans on what you read here – this is only a first step. Though tax rules tend to be simple in themselves, the mind can start to boggle when they intersect. When Daniel was a bachelor and employee with one rental flat, it took him an hour to add his property income to his tax return. Now that we’re married with a business, several properties, dividends and other income, a good tax specialist does it for us – saving us thousands of pounds. Tax is one area where expert advice is worth every penny. Don’t leave (or sell) your home without it.