What is the “Tenant Tax” or “Clause 24”? (Removal of Mortgage Interest Relief)

Historical archive, snapshot from 6 December 2019. The figures, tax treatment, mortgage product and links below reflect the article as archived, not current advice. Some links may no longer work. Check current rules and seek professional tax advice before making decisions.

Clause 24 of the Finance Bill 2015 changes how landlords are taxed.

The change in how the income from rentals is taxed is that it is now added gross to other income. In addition, mortgage interest and other costs can only be offset at the basic rate of tax.

These are the matters we are looking at today, not the extra 3% Stamp Duty, the general wear and tear allowance being withdrawn or PRA tighter minimum rent requirements on property affordability.

Tenants will presume that landlords' income has dropped by £X; therefore they may expect their rents to rise by the same £X. This is wrong: the increased rent, too, has to go through the tax system.

To explain this, we will use Mr Leeds Average.

Related reading:

• A Landlord Review of 2016
• Limited Company Buy to Let: Advantages and Disadvantages
• How LTD/SPV buy-to-let mortgages work

Who is Mr Leeds Average?

Mr Leeds Average is a model of the average landlord in the city of Leeds.

Average house price in Leeds is £185,536 (RightMove) and the average three-bed rent is £899 (Leeds Market Rent Summary). Most landlords have a day job and the average Leeds income is £35,000 (payscale).

If we presume a mortgage interest rate of 3.54% (a then-current 75% LTV Mortgage Works tracker product), the interest payments are £297 per month.

How much is Mr Leeds Average taxed?

If we run these figures through the BUY TO LET TAX CHANGE CALCULATOR created by mortgage lender The Mortgage Works:

Mr Leeds Average would have net rental profit of £4,822 charging £899 rent per month in 2016.

Mr Leeds Average would have net rental profit of £4,505 charging £899 rent per month in 2020.

A small loss of £317 a year to the tax man (£26.40 per month).

As we know Yorkshiremen are prudent people and Mr Leeds Average wants to keep his net profit of £4,822.

Increasing rent by £317 a year (£26.40 per month) will do that? No.

Mr Leeds Average would have net rental profit of £4,692 charging £925 rent per month in 2020, still £130 less than 2016.

To get to the same net profit of £4,822, Mr Leeds Average has to increase rents to fill the £26.40 per month tax gap by £44.00 per month.

Mr Leeds Average would have net rental profit of £4,821 charging £943 rent per month in 2020.

Clause 24, tax calculation for basic-rate taxpayer.

I know. But you have to explain Mr Leeds Average first as a basic-rate taxpayer, as the government insists that only one in five landlords is affected.

This is wrong and it is more accurate to say that 100% of tenants are affected, which is why it is nicknamed “the Tenant Tax” rather than Clause 24 of the Finance Bill 2015.

How much is Mr Leeds Higher-Rate-Taxpayer taxed?

If we increase Mr Leeds Average's non-buy-to-let income from £35,000 to £50,000, the results are a lot more shocking.

Mr Leeds Average would have net rental profit of £3,617 charging £899 rent per month in 2016.

Mr Leeds Average would have net rental profit of £2,905 charging £899 rent per month in 2020.

A loss of £712 a year to the tax man (£59.33 per month).

Increasing rent by £712 a year (£59.33 per month) will do that? No.

Mr Leeds Average would have net rental profit of £3,332 charging £938 rent per month in 2020, still £285 less than 2016.

To get to the same net profit of £3,617, Mr Leeds Higher-Rate-Taxpayer has to increase rents to fill the £59.33 per month tax gap by £99.00 per month.

Mr Leeds Average would have net rental profit of £3,617 charging £998 rent per month in 2020.

Clause 24, tax calculation for higher-rate taxpayer.

Will landlords raise rents?

Yes, if the market allows, landlords will look to retain profits.

This depends on the market; not all areas will allow landlords to raise rents. That may change with construction at low levels and an increasing population, along with the presumption that fewer landlords will enter the market and some may sell. The already high demand for rental accommodation may allow rents to rise.

In a survey, the Residential Landlords Association found that 84% of private-sector landlords were likely to consider increasing rents.

What tax planning can be done?

Mortgage statistics have shown a large switch from landlords buying in personal names to buying in a limited company.

Companies maintain mortgage interest relief and can reduce personal tax liability with retained profits.

Moving properties from a personal name to a limited company is not so simple either. To do it today would involve a sale and purchase, resulting in tax liabilities of SDLT and capital gains.

Accountants are advising a path of incorporating a person's property portfolio into a limited company first via an LLP, but it takes a few years and requirements set by HMRC may prevent some.

Limited-company buy-to-let may not be the most tax-efficient option: Mr Leeds Average had to pay an extra £317 a year to the tax man, paying an accountant to file company accounts may cost that, regardless of other tax factors. It is wise to take professional advice from a tax adviser and your mortgage broker. If you are looking at a portfolio or are a higher-rate taxpayer, then a limited company makes a lot more sense.

The mortgage comparisons below show current products, not the historical rate used in the example above. Tax decisions need individual professional advice.