Buy-to-let mortgage interest tax relief

What are the changes to buy-to-let tax relief?

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Landlords may find it harder to make a profit as a result of changes to tax relief on rental income – here’s why

Being a private landlord has historically allowed you to take advantage of significant tax relief by offsetting your mortgage interest payments. But rules introduced in April 2017 mean that some landlords now pay more tax on their rental income.

Tax relief on buy-to-let mortgage payments

If you were a private landlord before April 2017 with a mortgage on your property, any interest you paid towards the mortgage payments could be deducted from your rental income before you paid tax on it.

For example, if you made £10,000 a year in rental income, and your annual mortgage interest payment amounted to £9,000, you could deduct the £9,000 from your rental income. This meant you would only pay tax on the remaining £1,000 – so if you were in the 20% tax bracket, your tax bill on rental income would have been £200, rather than £2,000

What are the new buy-to-let tax relief rules?

Since the start of the 2017-18 tax year though, the new buy-to-let tax system has been phased in. Rather than an immediate change, the new rules will be introduced gradually year by year until they are fully in place by 2020.

This means that every tax year during the transition period, the percentage of your mortgage interest payments that you can deduct from your rental income will decrease by 25%, and the portion of those interest payments that qualify for the new tax credit will increase by 25%.

Tax Year

Percentage of mortgage interest payments deductible from rental income

Percentage of mortgage interest payments qualifying for the new 20% tax credit

Before April 2017

100%

0%

2017-2018

75%

25%

2018-2019

50%

50%

2019-2020

25%

75%

After April 2020

0%

100%

 

By 2020, you won’t be able to deduct any of your mortgage interest payment from your rental income before paying tax – instead, the entire sum of your interest payment will then qualify for a 20% tax relief.

This means that a landlord getting £10,000 in rent and paying £9,000 in mortgage interest payments will end up paying tax on the full £10,000 – though the amount will still depend on their tax bracket.

They will then be able to deduct £1,800 from their tax bill due to the 20% tax credit, leaving them with the final overall tax bill on their rental income.

 

Tax bracket

Tax bill on £10,000 annual rental income

Tax relief (20% of £9,000 mortgage interest payments)

Total tax bill before April 2017

Total tax bill in 2020

20%

£2,000

£1,800

£200

£200

40%

£4,000

£1,800

£400

£2,200

45%

£4,500

£1,800

£450

£2,700

 

Landlords in higher tax brackets could then end up paying much more tax than before, as they’ll be paying a percentage of the total rental income rather than the rental income minus their yearly mortgage interest payments. And the only tax relief they’ll receive is 20% of their interest payment, instead of the entire amount.

What are the key changes to taxes on rental income?

While landlords could find themselves paying more tax on their rental income, there are other changes that the new rules could bring in:

  • A higher tax bracket: The rental income you use for interest payments must now be declared, which means you might find that you move up into a higher tax bracket
  • Negative earnings: Some landlords who have smaller profit margins may find that they are in the red after tax – they could end up losing money

What does this mean for the future of landlords?

The changes to mortgage interest tax relief only affect private and individual landlords, and many are now setting up their own limited companies to try and reduce the impact of the new system.

It’s important to know that the process of transferring property ownership from yourself to your limited company will still count as a sale, which means you may have to pay capital gains tax – in order to be sure about the finances involved, you should seek out expert financial advice.

You should also consider that companies are unlikely to get the same choice of mortgages, instead being offered a limited selection.

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