Budget impact of 2% additional tax on Section 24

 In Rachel's budget she increased the tax on rental income by 2%.   The "good news" is that the Section 24 relief also shifts by 2% for 20% tax payers and also 40% tax payers get the basic rate of tax relief for section 24 increased by 2%.  It could have been worse and not shifted and be stuck at 20%.

Ignorng the fact that Rachel can't do basic maths and incorrectly stated the "difference" in tax landlords pay  compared to tenants.

So what's the impact?

Let's assume someone is a basic rate tax payer with an income of £12,570 and has rental profits before interest of  £10,800. The interest on the property loan is £4,000.

So currently the rental profit of £10,800 is taxed at 20% = £2,160 tax and gets a relief of £4,000@20% = £800 so total tax of £1,360

So from April 2027, rental profits will be taxed at 22%.  In this example the order of taxation is the £12,570 income is taxed first so the rental income will be subject to taxation at 22%.

So £10,800 is taxed at 22% = £2,376 tax and gets a relief of £4,000@22% = £880 so a total tax of £1,496

So that's a 10% relative increase in overall tax.  Why 10% ?  22%/20% = 1.1 hence 10%.

So let's re-run this for a 40% tax payer.

We will assume their income is £50,750 and they have rental profits before interest of £10,800. The real profitability before tax is £10,800 - £4,000 so £6,800 gross profit.

Currently this is taxed at 40% so £10,800 @ 40% = £4,320 and an interest relief allowance of £800 (at the 20% rate) so tax of £3,520. With REAL profits being £6,800 this is an effective taxation rate of 52%.

So if we re-run this for the 27/28 tax year that tax of £10,800@42% = £4,536 and relief of £880 so tax of £3,656 - so an effective tax rate of 54%.

In relative terms you will be paying 4% more tax on your rental "profit" (£3,656/£3520).

If you are a 40% tax payer and highly geared then you are paying tax on a loss and will pay yet more tax on your loss after April 2027.  Either reduce your gearing or sell-up.....

Be aware that the order of taxation is also changing from 2027 to

i) Employment income, self-employment trading income, and pensions

ii) Property income

iii) Savings income

iv) Dividends

So if you have property income and savings income (or dividends income) this will bubble to the top and attract the highest applicable rate of taxation. 

Returning to our calculations, if the 20% tax payer decides the £216 she is now paying in tax is unacceptable and decides to increase rents to compensate then the rent will need to increase £277 per year to be neutral.

Overall the tenant is the loser.  Tenant is paying £277 per year more.  The landlord is neutral. Rachel is £277 better off....

Basically the less mortgage debt you have, the more profit you have therefore more tax you have to pay so the more the rent increase will need to be compensate.


 

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