Ruban Selvanayagam, Co-Founder of Property Solvers, on why landlords need to wake up to the effects of Section 24.
Back in July 2015, former Chancellor George Osborne unexpectedly sprung Section 24 of the Finance (No. 2) Act.
The legislation essentially restricts mortgage interest tax relief for personally-owned residential property.
Before coming into effect, landlords could offset 100% of their mortgage costs against annual rental revenue. By the time Section 24 fully rolls out, we will only be able to deduct 20% credit on mortgage costs.
Why was it introduced?
The reasoning behind Section 24 remains a moot point. There is, however, a broad consensus that it came as part of a raft of top-down measures aimed at stemming the growth of the buy-to-let sector.
In April 2016, for instance, stamp duty for buy-to-let and other second home purchases effectively doubled. Then the 2017 Prudential Regulation Authority (PRA) stress-testing criteria placed notable restrictions on landlords’ leveraging capacity.
In short, landlords have become the easy target.
What Landlords Should Know About Section 24
- The legislation will be phased in over the next four years. For the 2017/18 tax year, landlords can claim 75% tax relief. Over the following 3 tax years, the available relief will decrease in 25% increments until 2020 (to 0%). However, note there is a mortgage cost tax credit of 20% (the basic rate of income tax);
- The initial impact of Section 24 will only be truly felt upon receipt of the 2018/19 tax bill (due at the end of January 2019);
- Landlords that own property in a Limited company (typically a special purpose vehicle) will not be affected. They will still be able to offset 100% of mortgage interest costs;
- The amount of tax payable will depend on what tax bracket the individual landlords is in. For instance, those in the lower tax bracket may not be impacted at all by these changes;
- If a landlord has a high amount of borrowing secured against the property, the potential tax liability is likely to be higher.
What Are the Options to Mitigate the Effects of Section 24
Below are some of the more practical strategies to counter the effects of Section 24 that landlords have been implementing in recent years:
- Deleveraging buy-to-let portfolio holdings: make capital repayments or perhaps transfer lump sums from existing savings to your mortgage account(s);
- Transferring buy-to-let properties to a spouse or civil partner: this strategy assumes that he/she is a low rate taxpayer. It would be important to confirm that any supplementary rental income will not push your spouse or partner into the higher tax bracket. It could also become difficult for your partner to earn any extra income in the future without crystallising extra tax liabilities as a result of Section 24;
- Portfolio buy-to-let property owners could divest and effectively clear personally-owned mortgages: the idea would be to use the proceeds of sale to make further acquisitions within a more tax-efficient Limited Company structure. Should you be considering this option, remember that Capital Gains Tax (CGT) on the proceeds of sale will be due (not mention stamp duty on new acquisitions). It’s also worth thinking about the practical effects that any disposals will have on cash flow and existing tenancy agreements;
- Increasing rents: according to government data, the number of homes for private rent fell by 46,000 between March 2016 and March 2017 which may suggest that rental rises are imminent (due to constraining supply). However, much will depend on local market dynamics. Landlords will have to be certain that homes are still genuinely affordable and that price rises are justified by decent standards;
- Transferring properties into a limited company “wrapper”: this is a process by which buy-to-let property owners effectively ‘sell’ properties to a corporate structure. In this scenario, both capital gains tax (CGT) and stamp duty (SDLT) are crystallised at market value (not at the purchase price). CGT can be minimised by means of incorporation relief – however there are strict rules governing if and how this can be done. Similarly, portfolio landlords could explore multiple dwellings relief, taxation at non-residential rates and transferring properties into a partnership to limit SDLT liabilities. It’s worth noting that unused property losses (as an individual) cannot be transferred over when transferring properties into Limited company ownership. Furthermore, landlords would also have to refinance with a Special Purpose Vehicle (SPV) buy-to-let lender, thereby potentially losing any competitive rates;
- Deed of Trust arrangements (also known as Beneficial Interest Company Trusts): perhaps one of the most contentious areas, an artificial structure is used to transfer the beneficial interest of a property into a Limited Company whilst retaining title and the existing mortgage in one´s own name. The general advice from experienced tax advisors is to avoid such schemes. The Income Tax Act prevents individuals from transferring an income stream into a company for tax reasons. Most (if not all) lenders terms and conditions will also not permit the mortgage of a personally owned property to be transferred into a company in this way. Moreover, you may be open to allegations of “mortgage fraud” which, in a worst-case scenario, could lead to the loan being called in or even more serious legal action.
Crucially, before embarking on any tax mitigation strategy, it is imperative to undertake a detailed cost-benefit analysis and speak to a qualified accountant / tax advisor. A suitable professional will be able to advise you on the best way to “financially engineer” any portfolio restructure in line with your own circumstances.
You can also request a “pre-transaction ruling” or “non-statutory clearance” from the HMRC to provide more certainty that there will be no contraventions of General Anti-Abuse Rules (GAAR), Disclosure of Tax Avoidance Schemes (DOTAS) and other tax evasion legislation.
Where Next?
A frustrated Judicial Review attempt and a Chancellor with little intention of backtracking would lead us to believe that the chances of any kind of reversal look slim.
However, this doesn’t mean that the industry should implicitly accept Section 24. The National Landlord Association (NLA), Association of Residential Lettings Agents (ARLA) and “Axe the Tenant Tax” campaigns should all be lauded for their lobbying efforts to highlight the unfairness of this legislation. We would encourage readers to stay up-to-date with these bodies work, get involved and also write to your local MP.
If you haven’t already, remember to sign the petition seeking the reintroduction of full mortgage interest relief and removal of the 3% stamp duty surcharge. At 100,000 signatures, the petition will be considered for debate in Parliament.
The demand for decent quality rental accommodation shows little sign of waning. Despite all the negativity towards buy-to-let in recent years, there are serious opportunities for landlords and investors to capitalise on the changing tide.
For landlords determined to remain in the sector, seeking the correct tax advice is fundamental. Those looking at new purchases have been moving towards more tax-efficient special purpose vehicle (limited company) acquisitions. Although slightly more complex in terms of profit extraction and securing finance, they are generally deemed as a safer means of structuring future holdings.
Should you be considering a sale of your rented property to either deleverage and limit future tax liabilities or completely exit the buy-to-let, the team at Property Solvers would be happy to have a no-obligation chat. Please visit our