We sit down with our panel of experts and talk about what actually is section 24, and what it means for landlords in the long term.
Adam Lawrence: A professional landlord that has been involved in over 500 UK property transactions over the last decade. | LinkedIn
Watch the full episode on Youtube, listen to the podcast on My Property World Podcast or read the edited transcript below.
Today’s topic is section 24 mortgage interest relief. Christine, what’s your angle that we’re going to be looking at this from today?
I own a lettings business that operates across the Cotswolds. What landlords often say to me or ask me is, if this is really hitting me hard, what on earth am I supposed to do about it? What are my options? What can I do to mitigate this tax hit?
The first thing I say obviously is to go and talk to somebody who knows what they’re talking about. Talk to your accountant. But for small portfolio landlords often their accountants aren’t specialists in this area. And to get specialist advice can be expensive.
Adam, how did you go about approaching and finding a solution to this?
I was lucky, in 2012, I already decided I was going to wrap pretty much everything I was doing in limited companies. And that was, I was lucky because the mortgage environment was quite tough back then for individuals.
A lot of these landlords that you’re referring to Christine, you’ll find they did the majority of their portfolio accumulation, pre-2008. And they were doing lots and lots of transactions with effectively no money down because credit was so easy to come by.
I only had half a dozen in my personal name when George Osborne waved his magic wand in June 2015, and since then, I’ve disposed of them once a year to make the most of my CGT allowance, either in the open market or sold to one of my limited companies. It’s not incredibly efficient selling to the limited company, you’re obviously still having to buy the 3% additional stamp duty, apart from anything else and there are costs of doing that.
Let’s get into some details. There’s a lot of very good questions that we want to cover off today. But what actually is section 24? What does it mean?
Pretty good question given that’s what we’re talking about… effectively section 24 of the finance act is when George Osborne amended the tax legislation. What it meant was that landlords could no longer expense the full amount of their mortgage interest against their revenue. Instead, they would only get a tax credit rather than full expenses.
It has this really perverse way of effectively adding on the gross revenue that you receive calculating your taxable income. This has a number of consequences because it can take your job benefit out if you’re a small landlord who would still benefit from job benefits.
If it pushes you above the 100k, then you start to lose your personal allowance. If it pushes you into the 150k you’re being taxed at 45%, even when that’s not actually the sort of money that you’re making.
It then applies a tax credit of 20%. So, if you’re a basic rate taxpayer one property that’s worth 20 grand a year, and you’ve got a property that rents for 10 grand a year. It won’t make any difference. You can effectively sell expense your mortgage. But that’s not a common landlords profile. Let’s face it, it pushes people into tax brackets that they don’t deserve to be. Therefore, it basically forms the part of the tax on revenue rather than the tax on profits, which is very distortionary, and there are convoluted examples whereby you can see that people are paying over 100% tax, which obviously makes it unviable for them.
Probably the cleverest and most insidious part of it in many ways is that it was phased in over four years. So, we had 25% incidents a year and a lot of people who weren’t perhaps as clued up as we might be were getting caught slowly by this. I’ve only felt the pain of the full tax bill in January this year, which has not been a great year for landlords to start feeling actively painful tax bills either.
There’s an argument this is retrospective, people have built portfolios under the old legislation and it’s an unfair tax and I’d have to I’d have some sympathy for that argument. It also sets a precedent for taxes because if you went and started taxing businesses on turnover, and of course, there’s already a provision in the tax legislation to do this in the tech sector, but this sort of tax on turnover is actually quite a dangerous thing.
And what’s the reasoning behind this?
Do you want the above the line or the below the line answer?
Because the above the line, well, let’s put it this way since the 1980s homeowners can expense their mortgage against their income. So, why should the landlord be able to do it? It’s not fair. It’s levelling the playing field. There are too many second homes being hoovered up in areas in the southeast, particularly landlords, and they’re crowding out first time buyers, etc. I’ve never actually seen a database argument that proves this in any way, shape, or form, but that was the above the line argument.
The below the line argument might be that George Osborne and many of his cronies were receiving various shares in various institutions that were going to build up residential portfolios on the back of trying to force out the mum and dad landlord. There’s a lot of people who’ve got one or two properties, maybe they moved house and didn’t want to sell up or they inherited one and it didn’t make sense to sell at the time. And it’s these people that they’re trying to buy off, trying to force out of the sector because they want to open the playing field wide open for them to build massive institutional portfolios of residential property.
I think you’re right. We talked about this a bit last week, didn’t we? And there’s been an incremental push over the last 10 years or more to persuade, cajole, and then force small landlords with one or two properties into a position where they have to sell, where it’s not worth the stress, hassle, and fines.
The government seem to perceive them as being unprofessional. They think that they’re the ones who don’t provide good quality accommodation, perhaps, or they just don’t want them there. They’d rather see professional institutional investment. But, if you think about that long term, if that’s the way we go completely I mean, there was something on the TV last night about large investment institutions owning care home companies, and that’s the way it’s gonna go with all the money going offshore and none of the interests of the actual people who live in those properties being met.
I recall the piece that Christine’s referring to, it did an analysis of what portion of the state monies were going into the care home sector. And I think very roughly, I might have these numbers a little bit wrong. 65% of the money coming in, was going on staffing costs, then there were some other administrative expenses, and then something like 20% of the money was going on the repayment of debts to the owning companies. Which is a big chunk off the top.
If we apply that situation to the institutional residential portfolios, this is just going to force up the rents. I mean, I’ve acquired care homes for clients before, you know, national charities for example, where the vendors been in exactly that situation because they’ve had a lease which has proved to be completely unviable after about 5, 10 years because basically, the venture capitalists were controlling the debt on the freehold.
So let’s, let’s take an actual example.
Let’s keep it simple, we’ll say the investment property value is around £200,000. For this example, and we’ll say it’s a three-bedroom, terraced house. Now you’ve got an individual who has moved out and moved into another primary residence, and they’re left with this property.
They rent it for say £900, again we’ll keep it simple. We’ll say £150,000 of a mortgage.
Once you take out the various bits and pieces, what are we actually talking about in terms of the difference here?
Most high street banks will say you’re going to have to pay about 25% of your monthly income in costs in terms of maintenance, agency fees, insurance, all the other compliance requirements, etc. So, if you take 75% of your £900 a month rent you get £675. Then your 5% mortgage on the property is going to be about seven and a half grand over the year, which is going to be £625 a month.
You’re clearing a massive £50 a month in cash flow. And that’s why a lot of people who are in the game are in it for the long haul because they’re banking on capital growth. Because with those sorts of numbers there’s next to no cash flow. Then as soon as you introduce the taxation requirement, you can see very quickly that’s going to go into negative territory awfully quickly.
So they’ve got a new primary residence that they’ve moved into, and suddenly they’re furiously looking down the back of the couch for a few pounds to pay the section 24.
The big change on that front was actually when the PRA changed the interest coverage rules in 2017, which meant that you needed much more coverage to get bigger mortgages on rents and in London unless you fix the five years particularly low re you couldn’t release the capital from the properties and that that had a significant impact as well on and it’s part of that as Christine was dripping tap if we want to call it that of the suite of government policies. That has been there to discourage the smaller landlord and encourage the institutional landlord.
Definitely, as you say, Adam, before they increase the coverage required on the mortgage, it would be quite common for a landlord. I mean, I became an accidental landlord. And then because I bought my first house, and then a year later I decided to go to college like you do when you’re in your 20s Okay, so I rented it out and it created cash, it was easy. Easy peasy. No, trouble at all. But as time went on, to fund my college sort of social life, even though I had no income basically apart from my student loans and grants, I was able to take further advances and of course, they were completely free of tax. So, I did end up selling that house actually only because it was so heavily mortgaged. I didn’t see any point keeping it. I wish I had though, but there you go.
So that leads into a good question, actually. Adam, what can buy to let landlords do to reduce the impact of section 24?
Ah, the actual question. I think the smaller ones need to be on top of their expenses for a start. I think if they’re self-managing they could consider a management charge for their own limited company or their own partnership vehicle. This, by the way, is not tax advice. I’m not a tax advisor. These are just things that I’ve heard. And I know are in action for a number of people who’ve got bigger portfolios in their personal name.
Like you consider incorporation relief section 162 corporation relief. It’s not cheap to get done, but it might well be extremely commercially viable. So, that effectively is a part of the tax code that says if you’ve always run your sole trader, enterprise as a business, then you can move it over to a limited company and it can legitimately be considered as having always been a limited company. That has a number of benefits, one of the interesting parts of that is it actually moves them on to the company balance sheet at today’s value rather than the value that you purchased the property. So, it’s one way of deferring some of those capital gains that we were just discussing.
We might also get them to make the most of their mileage expenses. Do they go to property networking events? Are they members of the NRA? All of those legitimate costs. I put in a home office too. These are all things that you can do to minimise taxes because every other expense is still fully tax-deductible.
You can quite often find that ultimately it’s a rock and a hard place. There’s either a big cost to incorporate or divest, some of which will be capital gains tax, as Christine said, or you’re going to carry on swallowing massive tax bills for the rest of your life.
Now, the flip side of is property is gone up quite a lot in the last 12 months. So, that will help with some of the tax bills that people might have to pay when they dispose of their assets. Unfortunately, Logan, there isn’t really too much that they can do. Just like everything, there are two certainties in life, death and taxes.
If you’re the person who’s working away the rest of the time or you’re focused on things other than your property empire of one by two lets which are ticking away in the background. You’ve got all the usual things going on with tenants and toilets and maintenance and what have you. But in terms of section 24. What’s the risk of getting this wrong?
One of the big issues at the moment is the interest rate isn’t very high. So, I think we’ll see increases coming in 2022, if you’re struggling on the basis of very low rates, it’s only going to become more of a problem over time. Also, like always, if there’s a taxation issue, then you know, you pay your tax on the 31st of January. And it’s a lag indicator and if you pay in tax on profits you haven’t made it’s a problem.
Exactly. The interest rates we’ve got now are just unbelievably low. I think that was paying like 6%-8% or something and that was normal. I remember being in my car driving somewhere to a client one day when interest rates went up to 15% temporarily. So, I think most smaller landlords who’ve bought in the last few years, there’s no way they’d survive that.
the point one was when we went to point one, after the pandemic, you’ve really taken hold. It was the lowest rate for 25 years, but we haven’t been above point seven five since March 2009. So we now live in one of those classic situations, the last 13 years of everyone’s experiences have been in an ultra-low interest rate environment, you forget that other things can happen.
If the base rate was 6% at the moment, or even if the mortgage pay rate was 6% at the moment, then you know 95% of landlords would be out of business. We’d be clinging on by the skin of our teeth, but we wouldn’t be making a business out of it.
The other point is that sharp increases in interest rates would lower the value of property ultimately because it would withdraw credit availability from the market and that’s quite damaging, and ultimately one of the things that contributed to the 2008 property crash, So this is something people need to be considering.
I shared the story in the last podcast, I think, but I’ll share with you every one of our users was basically running a property portfolio of a spreadsheet but didn’t know his numbers. And then it wasn’t until they transferred all of his expenses and everything into Landlord Studio. He was only making about five pounds a month and he didn’t even realise.
I’ve done a few portfolio consultations and I’ve had people say oh this tax thing is gonna ruin me. And I’ve gone through the fingers with a bit of analysis and said, Well, I mentioned that 25% figure we talked about earlier in terms of running costs for your portfolio and found that some of these people are spending 50% on their running costs. And the actual tax was actually only going to make a 9% difference to them. But they’re overspending by up to 35% on their running costs.
So I think stage one, get a handle on the numbers. Stage two take some action based on those numbers. And make sure you know what you’ve got. So many people are not aware of what their agent is charging for a gas safety certificate or things like that, or they don’t know whether that’s a reasonable price or not. You need to be on top of all of those things. Some people invest in property as a hobby and that’s fine, but if you don’t run it as a business, you’re gonna go broke.
So Adam, if you have just one or two properties you’ve got two choices. Either you think I can’t afford or don’t want to be doing this anymore. In which case you would sell them. Or the alternative is to say if I really want to do this, I have to buy more properties. I have to get to a number of properties where I can then use whatever ways to transfer it into a limited company. Then you can afford to get properly set up as a business that’s actually worth something, because of course there’s a huge difference between just owning them in your own name as a hobby and having a business that you can sell.
The only thing that I might change from that, you might be better starting the limited company now rather than buy them in your own name and then incorporate.
This once again comes back to having a good handle on the numbers. But you’ve set me up perfectly for an “I told you so” moment. Back in 2015 when this all happened, I said in my inimitable style of trying to make things simple, look, this is George Osborne and the government giving us a simple message, go big or go home. But those are the two options you just described, basically. Those are the two options in my view.
Our closing comments. Logan, do you want to kick-off?
Yeah, it’s actually been really interesting, particularly around the method of transferring your properties limited company. I totally agree that actually, by doing that you’re actually creating a business that you can potentially sell later as a whole which may be something that a lot of investors never really think about, their exit strategy.
I think we also have to bear in mind, as Christine was saying, this is a decade long government strategy and it’s not over yet. I think being battle-hardened is important. Logan mentioned mindset there. That’s absolutely key. But I also think what the government is doing is creating a barrier to entry to new investors.
If you introduce new barriers to entry in a market, what happens is, like Christine was saying earlier, you’re talking about basic economics, prices go up. And ultimately, profit levels can go up, not down. So your big landlords massively prefer legislation. It gives them an advantage at scale. With a hundred properties you can afford to have someone being in charge of compliance, and 1000 you’ve got a whole compliance team. Ultimately, with one or two, you’re in charge of compliance and therein lies the problem.
I would just say that I echo Adam’s sentiment, go big or go home, basically. If you’re going to just putter along with your 1,2,3, even up to five or maybe even 10 properties, then you’re disadvantaged and Section 24 is just another incremental step. There will be more steps to discourage small landlords from being in this business.
You’ve got to make the decision and obviously get access to funding. That’s a big part of that decision. Yeah, it’s a tricky one because I think this blindsided quite a few people. It was totally unexpected. So we’re now all bracing ourselves for what might come next, which will probably be equally unexpected.