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Tax Strategies: What is Section 24? How to avoid it

Section 24 changed the UK buy-to-let market in an instant. The tax rise was announced in 2015. It’s now possible to make a loss on your buy to let, and still pay income tax! If that sounds nuts, it’s because it is!

The calculation of section 24 is convoluted. In this article, I answer the question “what is section 24” with some simple examples. I also provide strategies to avoid Section 24.

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What is Section 24?

Section 24 states that mortgage interest costs are no longer an allowable expense. So we can’t net it against rental income for tax. Section 24 was fully implemented in 2020, having been announced in 2015. You can’t net mortgage interest costs against rental income, but you do get a basic rate credit. The calculation is rather cumbersome. The net effect is as follows:

  • Higher rate taxpayers with a mortgage will pay more income tax
  • Some basic rate taxpayers will become higher rate taxpayers under the new rules
  • Some landlords could make a loss on a property, and still pay income tax!


Here’s an example of buy to let tax under the old rules:

  • James earns £60,000 from his job and is a higher rate taxpayer
  • He also owns a buy to let with £10,000 of rental income, £4,000 of mortgage interest costs, and £2,000 of other costs
  • Profit is £4,000
  • Net tax he will pay is £4,000 * 40% = £1,600


Here’s an example of buy to let tax under Section 24:

  • James will pay 40% tax on £8,000 (£10,000 - £2,000). This equals £3,200
  • He’ll get a basic rate credit of 20% * £4,000 = £800
  • The net tax he will pay is £3,200 - £800 = £2,400
  • Tax rise of £800


Sucks to be James!

Buy inside a limited company

Now we’ve answered “what is section 24?”, we can talk about how to avoid it. The most popular strategy is to buy your property inside a limited company. Section 24 only applies to properties held in your own name - not to properties held in limited companies.

Inside a limited company, you’re simply taxed on your profits. Profit = rental income – costs. Mortgage interest is just another cost. Your profit is taxed at the corporation tax rate.

There’s other advantages to holding a property inside a limited company. In particular, you have more flexibility with inheritance tax planning. I talk in depth about property taxes in this article.

To take money out of a limited company, you may have to pay tax again. I talk about how to do this efficiently in this article.

Transfer property to a Limited Company

Most buy to let purchases now occur inside a limited company. But what if you already own your property in your own name? To move your property into a limited company is called incorporation - this is where it gets complicated!

It can be very expensive to transfer a property to a limited company. The seller of the property will need to pay capital gains tax on the profits. Your limited company will need to pay stamp duty to purchase the property. These taxes often run into tens of thousands of pounds.

There are ways to avoid these taxes, but they’re not simple. One such method is partnership incorporation. If you structure your property business as a partnership, then you can incorporate and avoid stamp duty and capital gains tax. HMRC are sensitive to these transactions, so you need to do things correctly.

Holiday Lets are exempt

Furnished Holiday lets are exempt from section 24, so mortgage interest is a fully deductible expense. With the growth of Airbnb in recent years, this is a very attractive option for many landlords. I wrote a detailed guide on how to become an Airbnb host. Some things you need to consider are as follows:

  • The property needs to be available for a commercial holiday let for at least 210 days per year. It must be occupied as a commercial holiday let for at least 105 days per year
  • An ordinary buy to let mortgage won’t allow short term stays. You’ll need a specialist product
  • You’ll need a specialist insurance policy that allows short term stays
  • Holiday lets typically need a higher level of decoration, as you’re competing with hotels

Most city centre locations in the UK are suitable for holiday lets. Don’t assume that you need a cottage in Cornwall! I have a number of Airbnb properties myself, and love the strategy.

Transfer profits to a spouse

If you have a partner that’s a basic rate taxpayer, then you can transfer profits to them. For basic rate taxpayers, Section 24 has no effect. This is because you still get a basic rate credit of 20%, which is the same as the basic rate of tax. You might choose to transfer 50% or 100% of your property to your spouse, and then pay tax at a lower rate. Transfers between spouses are free of capital gains tax, so this is a popular and tax efficient strategy. 

Pay down your mortgage balance

Section 24 says that mortgage interest is no longer a tax deductible expense. But this only matters if you have a mortgage. If you don’t have a mortgage, then section 24 makes no difference at all.

With interest rates at historical lows, many landlords are paying less for their mortgages. This gives them more money left over, to pay down their mortgage. There will never be a better time to pay off your mortgage.

Conclusion

Section 24 was a significant tax rise for many landlords. But there are ways to mitigate and avoid the tax rise entirely. In this article, I explain clearly “what is section 24?” I’ve also provided a number of avoidance strategies that you can use.

As always, speak to an accountant before making any taxation decisions.

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