One of the biggest threat to private buy-to-let landlords today is Section 24 or The tenant tax.
We are one more tax year closer towards 100% implementation of section 24.
As an investor, we work with magical words like cash flow, yield, return on investment and many others. We all know that
Cash flow(net income) = gross income – mortgage interest – expenses – Taxes
Taxes are one of the aspects which we generally leave it to an accountant.
It will be too little too late to realise that your investment has become a liability.
Being a property investor if we don’t analyse the deal properly we will end up paying from our pocket instead of making money from the property.
What you are aware of you are in control of; what you are not aware of is in control of you.
Anthony de Mello
I’m not an accountant but I will try my best to make it clear in this article what section 24 is, and what can you do to improve your cash flow on a buy to let property.
What Is This Section 24 Or The Tenant Tax?
Legislation for section 24 published in Summer Finance bill 2015, is one of the most controversial tax changes that will affect buy-to-let landlords.
Section 24 brings more money to the exchequer and takes money from pockets of private buy to let landlords. I will discuss more details of the impact in further sections.
Section 24 is introduced gradually from 6th April 2017.
In simple terms:
when running a buy-to-let, landlords incur different financial costs.
- Mortgage interest
- Loans to buy furnishing and fees included
Previously landlords were able to deduct all the financial costs from the rent received and pay tax on the profit.
Once legislation is in force, private landlords will not be able to deduct full financial costs. The amount they can deduct will gradually go down as mentioned in the next section.
Must Read: Buy To Let: 8 Questions You Should Ask Before You Buy A Property
Section 24 Phases
Section 24 is being phased in over four stages
Stage 1 was implemented on April 6th 2017. From this date, a higher rate tax relief could still be claimed on the first 75% of mortgage interest. The rest would be taxed at the basic tax relief level.
Stage 2 was implemented on April 6th 2018. From this date, landlords could claim 50% of mortgage interest costs at the higher rate tax relief and 50% at the basic rate of tax.
Currently we are in stage 3 of section 24 in implementation.
At this stage, landlords can claim only 25% of mortgage interest costs at the higher tax relief rate and now 75% at the basic tax relief level.
You will only be able to claim tax relief at the basic rate of tax of 20% by April 2021. This is the final stage of section 24.
Impact Of Section 24 On The Property Market
Private landlords have been investing in property for years. All the private landlords with 100s of properties will be at a loss, if they don’t act now. They will have to shell out thousands of pounds in taxes resulting in loses on their property portfolio.
Many landlords have started putting their properties for sale. In some cases, whole portfolios are up for sale.
Be it the B word (BREXIT) or the number of properties available in the market due to Section 24; the property market has gone into a bit of chaos:
- Property prices have gone down nearly 4% in a few areas.
- People held to their money thinking prices will come down
- Landlords who are trying to sell a single property are struggling to get a decent price.
- People started paying off their mortgages
Must Read: 5 Property Mindset Habits To Shape You Up As An Investor
Tax Calculations Of Section 24
Understanding tax calculations will help in understanding your cash flow.
Current UK Income Tax rates and bands as of 22nd April 2019.
With the above information, let’s understand how the property income can affect if you are a private landlord:
Up to £50000, you would pay about 20% of tax.
Any income above £50000 is taxed at 40%.
If you earn £1000 above £50000 tax payable will be £400.
Tax Calculations Before Section 24:
Monthly Rental income £1000
Monthly expenses at 20% = £200
Mortgage interest = £500
Net Profit = Rent- expenses -Mortgage
= £1000 – £200 – £500 = £300
If taxed at marginal rate 20% = £60 which means Cashflow = £240.
If taxed at a higher rate of 40% = £120 which means Cashflow = £180.
Tax Calculations After Section 24
Monthly Rental income £1000
Monthly expenses at 20% = £200
Mortgage interest = £500
Flat 20% tax relief on interest = £500 x 20% = £100
Taxable Net Profit = Rent- expenses
= £1000 – £200 = £800
If taxed at marginal rate 20% = £160 (20% of £800)
which means Cash flow = £240
Breakdown of Cash flow = Profit before tax = £1000 (Rent) – £500 (Mortgage) – £200 (expenses) = £300
Tax @20% of £800 = £160.
Net Profit = £300 (profit before tax) – £160 (basic tax) + £100 (20% tax relief) =£240.
If taxed at a higher rate of 40% then
Net Profit = £300 (profit before tax) – £320 (higher tax) + £100 (20% tax relief) =£80.
For a lower tax rate payers, there is no impact based on this example.
For a higher tax rate payer, cashflow has dropped from £240 to £80. A drop of £160 in the cash flow.
If you are currently closer to £50000 (e.g. £48,500), then you will be moving to a higher tax rate slowly and steadily over four years and will start loosing out on the amount of money you can make.
This is the main reason why private landlords are choosing to either sell the property or transfer it to a limited company, whichever works for them.
Please discuss with a financial adviser, tax consultant or an accountant before taking any decision.
Must Read: Property Investment: How To Invest In Property?
How Can You Increase Your Cash Flow?
Pass Tax To The Tenant
Pass additional tax charged to the tenant. Be mindful if there is enough demand for the property at the increased rent. It will massively affect your cash flow if there are voids due to increased rent.
Setup Limited Company
If the property is purchased or transfer the rental property to a limited company, the profits will be taxed at 20%. If you transfer property to the limited company, you may have to to pay stamp duty for sale. There may be other taxes based on how the funds are transferred to your account. Other taxes may include PAYE, NIC and also taxes on dividends.
Pay Down The Mortgage Debt
You can reduce the financial costs incurred by paying off the mortgage and reduce the interest you pay. This will help in paying the tax on profits landlords make, instead of paying interest and paying tax as well on the interest you pay.
Additional Voluntary Contributions(AVC)
An Additional Voluntary Contribution (AVC) plan is set up by an employer for employees to make further contributions to potentially build up additional retirement benefits. It is designed to sit alongside the main company pension scheme.
If your income is close to 40% tax band, then you could try and reduce your tax liability by using AVC pension schemes.
Other Advantages Of Marriage Or Civil Partnership
You can split the income to be taxed 50/50 to the actual ownership ratio which could be more tax efficient.
Reduce Maintenance Costs Involved
Letting agents fee, maintaining the property well to reduce maintenance costs, anything you can do to reduce the maintenance costs will help in your cash flow.
Property Strategies Not Affected By Section 24
- Rent to Rent (R2R)
- Purchase Lease options (PLO)
- Furnished Holiday Lets (FHL)
- Serviced Accommodation(SA)
Opportunities Created By Section 24
Every situation can be challenging for one person but an opportunity for someone else
- As a property investor, we get to create a solution to other portfolio landlords by using purchase lease options(PLO)
- There are businesses opening up helping people to transfer portfolios to limited companies. Ensure the process is legal before starting the process.
- Lots of accountants started creating solutions for property investors to open limited companies
Must Read: 7 Key Things To Include In Your Property Offers System
“Where focus goes, energy flows.”
Whether we see a situation as an opportunity or a challenge is entirely up to us.
It is best to discuss with your accountant, the options that will work for you, depending on your financial situation. It is better to become aware and take action rather than be ignorant and be sorry.