Section 24 Mortgage Interest Relief Cap

Simon Misiewicz

Simon Misiewicz

Expat & Property Tax Specialist

15th February 2020

What is Section 24 mortgage interest relief cap? The new tax rules

You may be interested in our main article “buy to let tax for UK landlords”. This article discusses all the different types of tax that you need to be aware of as a UK landlord.

HMRC in all its wisdom will say that the mortgage interest that you pay on your property portfolio will be treated as zero cost. Therefore, the higher geared your property portfolio is, the greater income you will be deemed to have received.

Pre 2017/18 property investors were allowed to offset 100% of the mortgage costs against their property income. From 2017/18 the amount of mortgage interest that will be allowed to be offset against property income will be reduced to 75%. There will be a further reduction of 25% each year until 2020/21 when no allowance will be made to offset mortgage interest against property income in order to calculate the tax due.

Optimise - Section 24 mortgage interest relief cap

In place of mortgage interest being a tax-deductible cost will be a 20% tax reducer. This tax reducer is calculated as 20% of the lesser of

– Mortgage interest costs

– Property profit (clearly excluding mortgage interest as a cost)

– Taxable income as a whole

The tax reducer will start at 25% for the tax year 2017/18. This will increase by 25% until 2020/21 when the 20% tax reducer will be set at 100% of the above values.

As you can see HMRC are replacing the mortgage interest cost allowance with the mortgage tax reducer.



Section 24 mortgage interest relief example

John is an employee earning £50,000 and had the following income/costs for property in 2016/17

– £50,000 rental income

– (£20,000) mortgage interest cost

– £30,000 property profit

– £12,000 buy to let tax liability (as a higher rate taxpayer paying 40% tax = £30,000 x 40%)

In 2017/18 the situation will be:

– £50,000 rental income

– (£15,000) mortgage interest cost (reduced from £20,000)

– £35,000 profit

– £14,000 buy to let tax liability (as a higher rate taxpayer paying 40% tax = £35,000 x 40%)

The £14,000 is reduced by the tax reducer as follows:

25% of the 20% tax reducer rate is 5%. The 5% tax reducer rate is the lower of

– £35,000 property profit

– £15,000 mortgage interest

– £85,000 taxable income

Therefore, John receives a tax reducer of £750 (£15,000 X 5%). The tax liability is then:

– £14,000 tax calculated as above less

– £750 tax reducer

– £13,250 tax to pay

As we can see John now pays £1,250 more tax in 17/18 than he did the prior year on exactly the same amount of real profit made.

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The Buy, Refurbish and Refinance (BRR) strategy

Many UK landlords like to state that they have “no money left in the deal”. This means that they have purchased a property, added value and refinanced it. The amount of refinancing means that they pay themselves out of the deal. This is known as the buy, refurbish and refinance strategy.

Lucy buys a buy to let property for £100,000, which was 25% below market value. Lucy puts in £25,000 of her own money and £75,000 mortgage.

She modernises the property by installing new kitchen and bathroom features. Lucy also takes the time to redecorate the entire property and outs in new doors and windows. Lucy spends £50,000 on the property.

The deposit and refurbishment is now an investment by Lucy of £75,000

Lucy approaches the mortgage broker and is able to get a mortgage of £150,000 in just six months. This is because the values feel the property is now worth £200,000.

Lucy now has no money left in the deal as £150,000 increase the loan debt by £75,000.

This all sounds very good and well. However, the amount of mortgage interest that she now needs to pay has increased. This decreased the profit now made, Lucy does not get the full tax relief on this investment and is now in danger of not making any money at all.

You need to ensure that you do the calculations when you embark upon the BRR strategy.


Basic rate taxpayers become higher rate taxpayers because of Section 24 mortgage interest relief cap

It is possible that the basic rate becomes higher rate taxpayers. This is because the mortgage interest cost is moved out of the property profits. This means that taxpayers will show a greater paper profit than actually realised. This is all because of the new tax rules for mortgage interest.

Joan owns a property portfolio and has other income amounting to £15,000 that takes up her tax-free personal allowance.

– £70,000 rental income from her buy to let properties

– £15,000 property costs

– £25,000 mortgage interest costs

– £30,000 profit

– £6,000 tax

– 20% tax of the property profits made (£6,000 income tax divided by £30,000 property profits)

Someone that earns £30,000 is a basic rate taxpayer, even when the personal allowance is taken up by other taxable income. This is certainly the case before the impact S24 mortgage interest relief restriction. However, now that  S24 is fully enforced Joan’s self-assessment tax return will look like this

– £70,000 rental income from her buy to let properties

– £15,000 property costs

– £55,000 profit

– £15,000 income tax (£35,000 X 20% basic rate tax band + £20,000 X 40% high rate tax band)

– (£5,000) less mortgage interest tax credit £25,000 X 20%

– £10,000 net income tax liability

– 33.3% income tax of the property profits made (£10,000 income tax dividend by £30,000 real property profits)

Part of the income tax calculator is at the basic rate tax band and an element at the high rate tax band. Many UK landlords that buy properties as an investment will pay more income tax than ever before.

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Loss of child benefit

Optimise - Section 24 and child benefits

If the person was claiming child benefit allowance they would be asked by HMRC to repay this. Child benefit may be claimed by individuals with children that earn typically less than £50,000. Anything above this amount will result in a child benefit reclaim by HMRC using the below formula.

Earned salary less £50,000

———————————     (% result) X Child Benefit Received

100

 

Someone earning £55,000 would have a tax charge of:

– 50% = £5,000 (£55,000 less £50,000) divided by 100

– £538.20 = 50% (above) £1,076.40 (52 weeks X £20.70).

Loss of personal allowance

Optimise Accountants: Section 24 mortgage interest relief and personal allowances

Some of you reading this will see that the person above has a taxable income of £95,000.

However, once the Budget announcement changes kick in (mortgage interest relief) fully the taxable income will be restated as £135,000. This means that the person will lose their personal allowance.

If you earn more than £100,000 then you will be aware that your personal allowances are being eroded by £1 for every £2 of earnings above £100,000.

Someone that now has a paper taxable profit of £130,000 would lose their entire personal allowance.

Someone that earns £120,000 would lose an element of their personal allowance, as follows:

£20,000 Excess of earnings limit =  (£120,000 earnings less the £100,000 limit)

£10,000 Reduction to personal allowance (£20,000 excess divided by 2)

£1,850 Revised personal allowance (£11,850 less £10,000)


Loss of pension allowance

You usually pay tax if savings in your pension pot goes above the annual allowance.

This is currently £40,000 a year, provided that you earned this amount of money.

As shown from the Government website from April 2016 you’ll have a reduced (‘tapered’) annual allowance if both the following apply:

your ‘threshold income’ is over £110,000 – this is your income excluding any pension contributions (unless they’re paid as a salary sacrifice by your employer)

your ‘adjusted income’ is over £150,000 – this is your income added to any pension contributions you or your employer make

For every £2 over the above-mentioned amounts, you’ll see a reduction of £1 to your pension contribution allowance.

Can you remortgage on a buy to let?

It is entirely possible that a property may be refinanced. An extra amount of equity will have been built up if the property increased in value. A property may have increased in value for a number of reasons:

– Property values in the area have increased over time

– The property owner added value to the property (more bedrooms, extensions, additional garages etc)

– The property may have originally been purchased below market value

Buy to let landlords may be able to pull more money out of their existing mortgage provided that there is equity in the property and the mortgage holder has a good credit rating. You normally have to wait at least six months from the date that you obtained the original mortgage to the date that you seek to refinance.

Please note that you will typically pay administration and arrangement fees on any remortgage. You are advised to speak with your mortgage broker to ensure that you understand all the associated costs with a remortgage. It is likely that you will pay more interest rates on a refinance than the original mortgage. This is because the risk profile of the debt is increased. Ultimately there is less debt for the banks to pull on if things go wrong.

You can visit USwitch to see what mortgage interest rates and charges may apply to you.


The stress test criteria when refinancing your buy to let mortgages

The last thing to consider is the % of mortgage interest repayment rate. Some lenders wish to see interest cover (stress testing) of 145%. This means that your net rent needs to be 1.45 times more than the mortgage interest charges. Lenders may not lend to you if the net rent does not meet or exceed their % criteria.

£10,000 net rent

£6,000 mortgage interest costs

The above shows that there is 1.67 times cover to meet the stress test condition of 145%. A buy to let landlord wanted to increase the mortgage and the interest charges increase as shown below:

– £10,000 net rent

– £7,500 interest rate

The stress test criteria is no longer met. This is because the cover is reduced from 1.67 to 1.33 (£10,000 divided by £7,500). It is unlikely that the lender would approve the remortgage application.

Refinancing a buy to let mortgage to release cash for a deposit on a property investment 

Let us look at an example. John has identified a property in Birmingham. It is a four-bedroom house and is near the university. The property will be rented out to students. There is a high demand so renting a property that is refurbished to a high standard should not be a problem.

£200,000 house price

£50,000 deposit is 25% of the property value

The £50,000 can come out of John’s savings account. John could refinance an existing buy to let property that is just down the road in Birmingham, which is also let out to students. He purchased the property 8 years ago when the house price was £140,000. John knows that the property is in even better condition than the one he is looking to buy. He speaks with his mortgage broker and they agree to re-finance the existing property

£140,000 original house purchase

£200,000 latest valuation on the property

£60,000 increased the value of the property.

The £60,000 allows him to take out 75% as a re-mortgage. John decides to proceed with this re-mortgage. John is now able to use the £45,000 for the deposit on the new house.

£50,000 deposit required

£45,000 released as a remortgage in the existing buy to let property

£5,000 more required for John to complete the purchase

John now only needs to pull out £5,000 from his savings account to buy the new property because he refinanced existing Birmingham buy to let property.

The mortgage interest cost associated with the refinancing is allowed to be offset against his property income as it is used for investment/business purposes.


Can I borrow more on my mortgage to pay off debt?

There are times when people use credit cards that have obscene interest rates from 10% onwards up to 135% (or even more). It makes more sense to remortgage a buy to let property where the rates vary from 1% to 8%, which is much less than the debt that you have.

Sarah has recently purchased a new home. He decided to treat herself and her two daughters to a nice home. The property is in the countryside with plenty of typical green scenery. She has an interior designer to help her bring more light into the property and increase the size of the windows so that she can see her horses roaming near the paddocks. She spent £50,000 on the redesign. This was £20,000 more than she budgeted for. She put the money on her credit card. Sarah was worried because the credit card interest rate was 15.8%.

Sarah can refinance her two-bedroomed buy to let flat that is situated in North London. She originally purchased the property in 2009 when the property prices were very low. At that time she paid £350,000. The property has now increased to £500,000. She speaks with her mortgage broker to work out how much money she should release.

The downsides when refinancing a buy to let mortgage to pay off debt

As Robert Kiyosaki says that there is good debt and bad debt. Good debt is where you are increasing debt to generate more investment income. Bad debt applies where you are increasing debt for lifestyle purposes and no additional income is generated. In the case of Sarah, I think it is clear that she has created bad debt. This is despite the fact that she has decreased the interest rate charges. She will now have less cash flow from her investments for her lifestyle choices.

Sarah will also need to be upfront with the mortgage company with the reasons why she wants to take out the extra finance. The fact that she is paying off debt needs to be considered by the lender and the mortgage broker. It could raise questions as to how Sarah manages her money.

Is it best to pay off buy to let mortgages?

Most clients of Optimise Accountants that are property investors typically opt for an interest-only mortgage. This means that none of the debt is being paid off. The debt will remain the same at the end of the mortgage term. All that is paid by the buy to let property investor is the mortgage interest costs.

What happens if the property investor dies?

Typically banks want their money back after 12 months unless the debt is assigned to someone else. If this cannot happen then the estate needs to have money in savings accounts or sell of the property portfolio to pay off the buy to let mortgages. This could be a disaster if the estate finds itself in a recession and is unable to sell the properties at the market value. They may need to be sold, below market value, in order to release the cash to pay off the mortgage

The person that spent many years building up equity in their property portfolio may be saddened to see that the values are wiped away. It is therefore important to consider how the debt is to be paid off in the event of the mortgage holder’s death. It may be a better option from a wealth planning aspect to put the properties in a repayment mortgage. They need to be aware that this will decrease the amount of cash flow that they receive from their property portfolio.



Other key benefits of paying off your buy to let mortgages

Another good reason for paying off the buy to let mortgage is to increase the cash flow of the asset. The less mortgage, the less interest. This means you have more cash flow to play with.

There may also be times where the property is providing you with a negative cash flow each month because of the mortgage interest/ capital payments. Decreasing the debt means that the interest and capital repayments will also be lower. This should help improve cash flow, especially if you are making a loss each month. An investment, after all, needs to bring in money into your bank account.

What are the implications of refinancing a buy to let property because of the Section 24 mortgage interest relief cap?

From 6th April 2020, buy to let property investors will only receive a tax reducer of 20% of the mortgage interest costs. This means that high rate taxpayers will lose 20% tax relief on mortgage interest costs. Additional rate taxpayers will lose 25% tax relief on the mortgage interest costs.

You may not be able to offset the full amount of mortgage interest costs if you refinance a property and a high rate / additional rate taxpayer.

From the above example, we could see that John already has one property in Birmingham and looking to buy another. The first property had the following characteristics

£140,000 property value

£105,000 mortgage

The mortgage had an interest rate of 2%. This means that the mortgage interest costs per year were £2,100. In 2016/17 John’s tax return looked like this from the one property in Birmingham.

£15,000 income

£2,100 mortgage interest costs

£5,000 other costs

£7,900 profit

As a high rate taxpayer, he knew that 40% of the profits would be paid to HMRC. The amount of tax that John had to pay on his Birmingham property was £3,160. This leaves John with £4,740

6th April 2020 mortgage interest relief cap impact in John’s property

If we roll forward a few years we will see that the mortgage interest costs will not be allowed to be offset against his property income.

£15,000 income

£5,000 other costs

£10,000 profit

£4,000 tax

(£420) tax reducer at 20% of the mortgage interest costs of £2,100

£3,580 net tax to pay

We can see that John now has £420 more tax to pay.

If John were to refinance the original property and increase the buy to let mortgage by £50,000 the following would apply

£1,500 additional interest because of the remortgage.

£300 tax relief

£300 lost tax relief because of the tax changes

In this instance, John is paying more tax as a result of the original mortgage. He is also paying more interest on the remortgage without the benefit of the full tax reliefs.


S24 mortgage interest relief cap solution – Use a Deed of trust

You could transfer property income If you have a spouse that is a lower tax earner. If they remain a basic rate taxpayer once the beneficiary of the properties is transferred then Section 24 may be mitigated. You will need to book some time with us to discuss this.

A deed of trust will be required to show that the beneficiary interest has been transferred over. If you currently own the property, then you will also need to complete a form 17 to tell HMRC that the beneficiary entitlement is no longer 50/50.

You need to be mindful that you need to speak with your mortgage lenders. Please see their terms and conditions to see if you can transfer the beneficiary of the property. If they require the second person to be added to the mortgage then there could well be an SDLT implication as there will be a land transaction based on their share of the mortgage. There is now a double effect with the 3% SDLT surcharge in addition to the SDLT standard rates.

S24 mortgage interest relief cap solution – Change of use: holiday lets / serviced accommodation and commercial properties

Section 24 only affects residential properties. If you were to change the use of the property to serviced accommodation, holiday lets or commercial properties then Section 24 may be mitigated.

You need to ensure that you get planning from the local authority to see permission to change the use of the property from C3 to the new use class. You can get more details from the planning portal.

Please check with the mortgage lenders. If you have a standard buy to let mortgage and wish to use the property for another use then you will need to seek alternative financial arrangements.

We have also written a more detailed article all about investing in commercial properties. Be sure to take a read.

By changing the type of income you make from the property is a clear way for you to mitigate the impact of the section 24 mortgage interest relief cap.

S24 mortgage interest relief cap solution – Make pension contributions

The less taxable income you have, the less tax you pay. It is clear that pensions contributions can mitigate the impact of the section 24 relief cap.

The maximum amount of money that you can invest in your pension is £40,000 per year. The actual pension contributions you can make is just £32,000 as £8,000 is added by the government. In practice £40,000 X 0.8.

The amount of pension contributions you can make is restricted to Net Relevant Earnings (NRE) of £3,600. This means how much money you earn in regard to:

– Employment income

– Self-employment income

Please note that property investment, interest and dividend income is not taken into account. If you only have a property income of £50,000 you will still be only allowed to invest £3,600 (NRE rate).

There are other financial benefits of making pension contributions such as National Insurance savings, reducing the impact of losing your personal allowance if you earn more than £100,000. It also helps you to maintain all of your child benefit allowances if you earn more than £50,000.

Salary sacrifice – net pay method

You will receive up to 45% tax relief (based on your taxable earnings). This is provided you have invested into your workplace pension using salary sacrifice.

Direct contributions (private pension)

The government will add up to 20% of your pension contributions if you have invested into a private pension directly. You will need to claim the additional 20% (for higher rate taxpayers) / 25% tax (for additional rate taxpayers) on your self-assessment.

You can get free independent advice on pensions from Money Advice Service and if you are 50+ in age then you can also book an appointment free of charge with Pension Wise


S24 mortgage interest relief cap solution – incorporation of your property portfolio into a limited company

We have written a separate article on how to incorporate your property business into a limited company. The laws relating to the Ramsey 2013 case at the Upper Tax Tribunal are as follows:

– 162 of the TCGA 1992 (for the CGT incorporation relief)

– 15 land and buildings FA 2003 (for the SDLT relief)

The process to move the properties into a simple/ordinary partnership. This is not to be confused with either a Limited Partnership or Limited Liability Partnership. After three years of operating as a partnership, you could incorporate it into a company tax structure.

Please note that the stamp duty charge is voided (ie never payable) by you following the below process however the CGT is simply deferred under S162 incorporation relief.

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