Introduced in April 2017, Section 24 is a tax law that directly impacts the amount of tax relief that landlords can receive. The ‘Tenant Tax’ was introduced in phases, but by April 2020, it was fully implemented and impacted hundreds of thousands of landlords across the UK.

In essence, before the law was introduced, landlords could deduct the mortgage interest payments from their tax bill, as well as the mortgage admin fees and other related costs.

Section 24 has meant landlords pay more tax now. All rental income is taxable, and mortgage interest costs remain tax deductible, but it must be claimed back and it’s capped at 20% - the basic rate of income tax. This stings the most for high earners.

Potentially, a higher rate taxpayer could be paying £8,000 in tax on their £20,000 rental income, whilst only claiming 20% of the mortgage interest, which would be £1,400 if the interest was £7,000 annually. This can dramatically impact the viability of renting for HNW individuals with large portfolios. This situation is also made worse by the lack of rental property supply, putting initial investment costs up too.

How to react to Section 24 and reduce its impact

When investing, we should focus on the things we can control, instead of what we cannot. The tax law may sting, but we should still focus on optimising our own processes and finances to help offset the impacts of Section 24.

The most immediate thing any landlord can do is review their current property costs. For example, if you have the time, ditch your property manager, and take control yourself, saving you the ~10% fee they usually take. It may be a hassle, but it could be enough to get you out of a cash flow crisis.

Other steps to take are to review your mortgage to see if you can find a more competitive loan, as well as looking to better manage profits and ownership between the family. For example, if you’re a high earner but your partner isn’t, then transferring ownership to them could mean Section 24 now has little impact as your partner is a Basic Rate taxpayer.

Two other options are to consider becoming a limited company or to move towards commercial property instead. Regarding the latter, Section 24 is only applied to residential property and is not applied to limited companies. Though of course, limited companies must pay capital gains and corporation tax, so it may not be a solution for everyone.

Alternative investments

Even though many people do not realise it, property is a controversial investment even pre-Section 24. A property will take up a fairly large percentage of your portfolio, meaning it lacks diversification.

Of course, the asset itself is stable, because people will always need homes to live in, but as Section 24 showed, there’s always a looming risk that policy changes will cause falling yields and render it unprofitable.

The best way to look at the downsides of rental property as an investment is to look at the benefits of alternative hands-off investments. Index funds, for example, share a similar history of reliable growth given a long enough timeframe, but require zero maintenance, time, or emergencies. No risk of bad tenants wrecking your asset or not paying rent, the investment itself is far more liquid, and the fees to buy/sell the investment are considerably lower.

With the help of Nationwide HPI and Investors Chronicle, we can see that the FTSE 100 yielded a better return since 2015 when considering just capital gains alone - and this doesn’t include the lower costs. Buy-to-let mortgages are becoming increasingly expensive with interest rate rises, and the FTSE 100 has performed comparatively poorly when looking at the S&P 500, which is easily accessible for UK investors.

One advantage of property rentals over index funds is the monthly income they produce - income that will not necessarily decrease just because of a recession or market crash. Therefore fixed-income loan notes are a consideration, with a 10%-15% PA payout over 1-2 years, or Capital Protected Bonds with an 8% PA payout.

There are many fixed-income investments that could be an alternative to your rental property. The key here is to consider the biggest benefit of all: multiple different investments can be made with the money raised from the sale of a single property. Being able to divide up your money into more investments will give your better asset class diversification.

Summary

For landlords that wish to stick out the pain points of Section 24 and interest rate rises, there is still some light at the end of the tunnel. It’s possible to take on more control of the business to reduce costs, as well as shuffling about ownership between family. Furthermore, the Fed is expected to cut interest rates in 2023, likely because of the imminent recession, and the Bank of England could follow suit.

It is worth considering, however, the declining profitability of property rentals in the UK. Tenant rights are improving, and rightly so, whilst the government appears to be focusing on landlords as a means to solve the housing crisis. First-time buyer schemes continue to be propped up to paper over the cracks, which hurts property investors as they’re competing against buyers that can get 95% mortgages and other advantages. In other words, property developers know they can get a good price with a first-time buyer.

Autumn Statement latest: Chancellor reveals tax rises for landlords

In the event that you do consider alternative investments, it’s possible to replace the monthly income you’re used to with fixed-income investments, like bonds. For a portfolio focused on capital gains and growth, a well-diversified equity-heavy portfolio could be a good inflation hedge.

For professional guidance with your property investments, visit www.thomaskellyholdings.co.uk. Thomas Kelly Holdings has rich experience in helping high-net-worth individuals reach their investing goals through diversified, optimised portfolios.

This Article is based on the views of the author is not nor should it be deemed to be advice.