Specialist US UK Tax Services: Section 24 vs US Interest

A UK buy-to-let owned by an American produces two different profit figures on the same rent. HMRC denies a deduction for mortgage interest and gives only a basic-rate tax reducer under the Section 24 finance cost restriction; the IRS allows the same interest in full on Schedule E. The result is a structural foreign tax credit mismatch that compounds every year it goes unfiled.

That single divergence is the most commonly mishandled item we see on US-UK rental returns, and it is the reason Specialist US UK tax services exist as a discipline in their own right. At Jungle Tax we prepare both sides of this filing for individuals who hold leveraged residential property in the United Kingdom while remaining within the US tax net. This guide explains exactly how each return is prepared, why the credit does not relieve the tax it is meant to relieve, and how the distortion behaves across a multi-year compliance catch-up. It is a preparation guide, not a restructuring guide.

What is the Section 24 finance cost restriction?

Section 24 of the Finance (No. 2) Act 2015 removed mortgage interest and other finance costs from the list of deductible expenses for individual landlords of residential property. The restriction was phased in from the 2017/18 tax year and has applied in full since 2020/21. Since then, an individual UK landlord computes rental profit before any deduction for finance costs, pays income tax on that gross-of-interest profit at their marginal rate, and then receives a separate reduction in their income tax liability equal to the basic rate applied to the allowable finance costs.

HMRC sets out the rules in its Property Income Manual at PIM2054. Three features matter for cross-border preparation:

• It is a tax reducer, not an expense. Finance costs never touch the profit line. They only ever reduce the tax charge, and only at the basic rate.
• It is capped three ways. The reduction is the basic rate applied to the lowest of: the finance costs for the year plus any unused amount brought forward; the profits of the property business for the year; and the landlord's adjusted total income above the personal allowance. Any amount denied by the cap becomes an unused residential finance cost carried forward indefinitely.
• It applies to individuals, not companies. Trustees of discretionary and accumulation settlements and personal representatives are also within scope. Corporate landlords deduct interest in the ordinary way.

"Finance costs" is wider than the mortgage coupon. It captures interest on loans to buy or improve the property, interest on loans to fund the property business generally, alternative finance returns, arrangement and broker fees, valuation fees incurred in obtaining the loan, and early repayment charges — but not exchange differences. It does not apply to genuinely commercial property, and since the abolition of the furnished holiday lettings regime it now bites on lettings that were previously outside it.

Why does a higher-rate landlord pay more even when the cash flow is unchanged?

Because the gross-of-interest profit inflates adjusted net income. A landlord taxed at 40% or 45% on a profit figure that has not been reduced by interest, who then recovers only 20% of that interest as a credit, suffers a real increase in liability. The inflated income figure can also push the taxpayer through the personal allowance taper, alter the High Income Child Benefit Charge position, and change the rate band applying to other income. For an American, it does something further: it changes the shape of the foreign tax credit.

How does the US treat the same interest on Schedule E?

The US has no analogue to Section 24 for rental property. Mortgage interest on a property held for the production of rents is an ordinary and necessary business expense of the rental activity, deducted in full against gross rents on Schedule E of Form 1040. The IRS explains the general framework in Publication 527. Foreign situs makes no difference to deductibility; the property is simply reported in sterling converted to US dollars.

The US return therefore shows a materially lower — and frequently negative — profit on exactly the same rent roll, for three cumulative reasons:

• Interest is deducted in full, not restricted to a 20% credit.
• Depreciation is compulsory. The building element (not the land) is written off on a straight-line basis under the Alternative Depreciation System because the property is used predominantly outside the United States. The UK gives no equivalent relief on the structure of a let dwelling.
• Different expense boundaries. Items HMRC disallows as capital may be depreciable in the US, and the UK replacement of domestic items relief has no direct US counterpart.

US versus UK: the same property, two returns

Item	United Kingdom (SA105)	United States (Schedule E)
Mortgage interest	Not deductible; basic-rate tax reducer only, subject to three caps	Fully deductible against gross rents
Arrangement and broker fees	Within the finance cost restriction	Generally amortised over the loan term
Depreciation of the building	No relief on the structure of a let dwelling	Mandatory straight-line depreciation under ADS
Furniture and appliances	Replacement of domestic items relief (like-for-like)	Capitalised and depreciated
Rental losses	Carried forward against future UK property profits only	Passive activity loss rules may suspend the loss
Tax year	6 April to 5 April	1 January to 31 December
Currency	Sterling	US dollars; sterling loan is a foreign currency obligation
Reported profit on identical rent	Higher	Lower, often a loss

Why does the foreign tax credit not relieve the US tax?

The instinctive answer is that UK tax is higher, so the credit covers everything. On a leveraged residential letting the opposite is routinely true. The credit is claimed on Form 1116, and the IRS sets out the framework at About Form 1116. Four separate mechanical problems arise.

The limitation fraction is computed on the US number

The credit for a category of income cannot exceed US tax multiplied by the ratio of foreign-source taxable income as measured under US rules to worldwide taxable income. The US measurement of this property is depressed by full interest and by ADS depreciation. So the numerator shrinks precisely because the US is generous, while the UK tax in the denominator of the taxpayer's expectations was computed on an inflated profit. The credit available is therefore small relative to the UK tax actually paid, and the excess becomes a carryover rather than a current relief.

The tax reducer is a reduction in tax, not an expense

Because Section 24 relief is delivered as a reduction in the UK income tax liability, the creditable UK tax for Form 1116 purposes is the liability after the reducer has been applied. Preparers who treat the reducer as if it were a deduction, or who claim the pre-reducer tax, overstate the credit. Conversely, allocating the correct share of a single UK self-assessment liability to the property income — as against employment, dividend and interest income within the same return — requires a considered apportionment, not a rule of thumb.

The high-taxed income kick-out

Rental income from UK real property is passive category income. Where the foreign tax on an item of passive income exceeds the highest US rate that could apply to it, the item can be re-characterised as general category income. Section 24 makes this materially more likely, because the UK tax is measured against a profit that the US has already reduced by interest and depreciation. A client with no other general category income then holds credits in a basket with nothing to relieve. This is the single most misdiagnosed outcome on returns we take over.

Two different years

The UK tax year ends on 5 April; the US year ends on 31 December. A UK self-assessment liability must be allocated across the relevant US calendar years, and the choice between claiming credits on a paid or accrued basis changes which US year absorbs which UK payment. The accrual election, once made, is binding for all later years. On a multi-year catch-up this choice is made once and then lived with, so it is made at the start of the engagement rather than discovered at the end.

What else diverges on the same property?

Depreciation you did not claim is still deemed claimed

US depreciation is "allowed or allowable". A taxpayer who filed Schedule E without depreciation still reduces basis, and will face the same recapture on disposal as one who claimed it. Correcting an omitted or incorrect depreciation method is not a matter of amending the earlier returns; it is a change in method of accounting, made on Form 3115 with a catch-up adjustment. On a catch-up engagement this is frequently the difference between a defensible filing history and a permanently distorted basis.

The sterling mortgage is a foreign currency obligation

For a US person whose functional currency is the dollar, a sterling-denominated mortgage is a foreign currency transaction. Repayment, remortgage or refinancing can crystallise an exchange gain that is ordinary income for US purposes and entirely invisible on the UK return. Clients often remortgage to release equity without appreciating that the event is reportable. There is no UK counterpart, so nothing in the SA105 prompts the question.

US losses may be suspended, not used

Even where the US return shows a loss, the passive activity loss rules commonly prevent its current use against other income. The special allowance for actively participating landlords phases out at higher adjusted gross income levels, which most of our client base exceeds. The loss is suspended and carried forward, so the American pays full UK tax on an inflated profit while receiving no current US benefit from the corresponding US loss.

The Non-Resident Landlord Scheme

An American living in the United States who lets UK property falls within the Non-Resident Landlord Scheme. Unless HMRC has approved receipt of rent gross, the letting agent or the tenant must withhold basic-rate tax from rent. That withheld tax is a payment on account of the UK liability, not a final tax, and it must be reconciled to the self-assessment before any figure is carried to Form 1116. Crediting the withholding itself is a common and material error.

The accounts are reportable too

The UK account that receives the rent, any deposit or reserve account, and in some cases balances held on the client account of a letting agent, are foreign financial accounts. They feed the FBAR and, where thresholds are met, Form 8938. A rental catch-up is almost never only an income tax catch-up. Our FBAR penalty calculator gives an indicative sense of exposure before an engagement begins.

How does the mismatch compound across a multi-year catch-up?

A single year's distortion is unattractive. Six or eight years of it behaves differently, because the errors interact.

• Unused finance costs accumulate on the UK side. Where the three-way cap denies part of the reducer — typically in a year of low profits, or where the personal allowance covers the income — the unused amount carries forward. A UK return prepared in isolation for each year, without tracking the brought-forward pool, understates relief in later years.
• Zero-UK-tax years strand US liability. In a year where the reducer wipes out the UK charge, there is no foreign tax to credit — yet the US return may still show taxable income once suspended losses and basis limitations are applied. The credit cannot be borrowed from an adjacent year at will; carryback is limited to one year and carryforward to ten.
• Basis drifts. Each unfiled or wrongly prepared year changes depreciation, and therefore adjusted basis, and therefore the gain that will eventually be reported on disposal.
• The streamlined narrative must explain it. Where the catch-up is made under the Streamlined Foreign Offshore Procedures, the non-wilfulness statement has to describe, in the taxpayer's own terms, why the UK returns were filed and the US returns were not. "My UK accountant told me the property made no profit after the mortgage" is a fact pattern we see constantly, and it is a coherent one — but it has to be stated accurately and consistently with the figures being filed. Our IRS streamlined filing specialists prepare that narrative alongside the returns, not after them.

How we prepare the two returns

The order matters, because each return needs a number the other produces.

• Build one property ledger, not two. Rents, agent statements, interest certificates, service charges, ground rent, repairs and capital works are captured once in sterling, with the loan documentation and completion statement attached.
• Prepare the UK computation first. Profit before finance costs, the finance cost pool including anything brought forward, the three-way cap, the reducer, and the resulting UK liability attributable to the property.
• Translate and re-characterise for the US. Apply the correct conversion convention consistently, split land from building, set the ADS life and in-service date, reclassify UK capital items against US rules, and run the passive loss and basis limitations.
• Allocate the UK tax. Determine what portion of the post-reducer UK liability relates to the property income, and to which US calendar years it belongs on the elected basis.
• Complete Form 1116 by category. Test for the high-tax kick-out before assuming a passive basket, and schedule the carryovers explicitly year by year.
• Reconcile the two. A closing schedule ties UK profit to US profit line by line, so the client can see exactly which item created the difference. Every return we deliver carries one.

What has changed for 2026?

Two UK developments alter the preparation of these returns now. First, the furnished holiday lettings regime has been abolished, so lettings that previously escaped the finance cost restriction and enjoyed capital allowances are within the restriction on the same terms as any other residential let — a step change for owners of UK holiday property who also file a Form 1040. Second, Making Tax Digital for Income Tax is being introduced for landlords by reference to qualifying income, bringing quarterly digital reporting obligations to property businesses that have historically filed once a year. Neither changes the US treatment, so both widen the gap rather than narrow it.

Errors we most often correct on returns we take over

• The UK reducer treated as a deductible expense on Schedule E, or the interest deducted twice.
• The pre-reducer UK tax carried to Form 1116.
• Non-Resident Landlord Scheme withholding credited as the final UK tax.
• Schedule E filed with no depreciation, or with a 27.5-year domestic life applied to foreign property.
• Land and building not separated, so the whole purchase price is depreciated.
• Passive basket assumed without testing the high-tax kick-out.
• Unused residential finance costs never tracked between UK years.
• Remortgage proceeds treated as non-events for US purposes.
• The UK rent account omitted from the FBAR because "it is only a rent account".

Who this affects most

Accidental Americans who inherited or acquired UK property long before they understood their US filing status. US executives on long UK assignments who kept a let property. Founders who retained a London flat after moving. Dual citizens whose UK accountant has filed impeccable SA105s for a decade while no Form 1040 was ever filed. In each case the UK side is often perfectly in order, and it is the US side — and the credit that was supposed to join the two — that has never been prepared. Our US UK tax accountants take both returns together; you can review the wider library of cross-border filing guides in our guides section.

Speak to us in confidence

If you hold a leveraged UK residential property and have US filing obligations — whether current, partially filed, or years behind — the Section 24 mismatch is almost certainly sitting in your numbers, and it does not resolve itself with time. We prepare both returns, quantify the credit properly, and where a catch-up is required we file it cleanly the first time. To discuss your position privately and without obligation, contact our cross-border team for a confidential consultation with a senior specialist.