Are you a landlord trying to wrap your head around the current rules for mortgage interest tax relief on your rental properties? If so, you’re definitely not alone.
The way landlords must declare rental income has gone through some dramatic changes in recent years, leaving many with higher tax bills.
It used to be that taking out a buy-to-let mortgage came with a substantial tax bonus. Landlords could deduct the full cost of mortgage interest from their rental income before calculating taxable profit.
But those days are gone. Now, we have a tax credit system that often works out less favourably, especially for higher and additional rate taxpayers.
Read on, and we’ll explain the current system for claiming mortgage interest tax relief, with some practical tips to help you stay on top of your tax affairs as a landlord.
The Basics of Mortgage Interest Tax Relief Changes
Before April 2020, landlords could deduct their mortgage interest payments from their rental income when calculating their taxable profit. This effectively reduced their tax bill, especially for higher and additional rate taxpayers.
However, since April 2020, this has changed. Landlords can no longer deduct mortgage interest as an expense. Instead, they receive a tax credit equal to 20% of their mortgage interest payments.
How the Changes Affect Different Taxpayers
The impact of these changes depends on your tax band, which is determined by your total taxable income from all sources (not just rental income).
Let’s look at some simplified examples. We will assume that the Personal Allowance (£12,570) has already been fully used by other income, such as salary. This means all rental profits are fully taxable.
Basic Rate Taxpayer (20%)
- Imagine your rental income is £15,000 per year, and your mortgage interest is £5,000.
- Under the old rules, you would’ve paid tax on £10,000 (£15,000 – £5,000), which is £2,000 at the basic rate of 20%.
- Under the new rules, you pay tax on the full £15,000, which is £3,000. But you also get a 20% tax credit on your £5,000 mortgage interest, which is £1,000.
- So your final tax bill is £3,000 – £1,000 = £2,000, the same as before.
Higher Rate Taxpayer (40%)
- Now let’s say your rental income is £15,000, your mortgage interest is £5,000, and you have a salary of £35,000.
- Your total taxable income is £50,000 (£15,000 + £35,000), which puts you in the higher rate tax band.
- Under the old rules, you would’ve paid 40% tax on £10,000 of rental profit (£15,000 – £5,000), which is £4,000.
- Under the new rules, you pay 40% tax on the full £15,000 of rental income, which is £6,000. You still get the 20% tax credit on your £5,000 mortgage interest (£1,000).
- So your final tax bill on rental income is £6,000 – £1,000 = £5,000, which is £1,000 more than before.
The key point here is that for higher and additional rate taxpayers, the 20% tax credit doesn’t fully compensate for the lost ability to deduct mortgage interest at their top tax rate (40% or 45%).
The Importance of Total Income
As the examples show, it’s your total taxable income that determines your tax band and, consequently, how much the mortgage interest tax relief changes impact you.
Even if your rental profits alone don’t push you into a higher tax band, your combined income from other sources (like employment or investments) might.
This is why some landlords who were previously basic rate taxpayers might now find themselves as higher rate taxpayers, even if their rental income hasn’t changed.
When Does Mortgage Interest Tax Relief Apply?
Let’s take a step back and answer, “Who can apply for mortgage interest tax relief?”
Mortgage interest tax relief applies to a wide range of landlords who own and let out residential properties.
To be eligible, you must meet the following criteria:
- Property Ownership: You must own a residential property that is being let out to tenants. This could be a house, flat, apartment, or even a room within your main residence (if you’re using the Rent a Room Scheme).
- Mortgage on the Property: You must have a mortgage on the rental property and be paying interest on that mortgage. The mortgage can be a buy-to-let mortgage or a personal mortgage that you’ve secured against the rental property.
- Rental Income Threshold: Your rental income must exceed £1,000 per year. If your annual rental income is below this threshold, you may be eligible for the property income allowance, which allows you to earn up to £1,000 in rental income tax-free.
- Landlord Status: The rules apply to all types of landlords, including individuals, partnerships, and limited companies. However, the way you claim the relief and the impact it has on your tax bill may differ depending on your specific circumstances.
It’s worth noting that these rules apply specifically to residential properties. If you own and let out commercial properties, different rules and allowances apply.
If you meet these criteria, you’ll need to declare your rental income and claim the mortgage interest tax credit when filing your Self Assessment tax return. The process for doing this is outlined in the next section.
Reporting Rental Income and Claiming the Tax Credit
To claim the mortgage interest tax credit, you’ll need to:
- Complete a Self Assessment Tax Return: If your rental income exceeds £1,000 per year, you must file a Self Assessment tax return.
- Use the UK Property Supplementary Page (SA105): Within your tax return, fill out the SA105 form to detail your rental income and expenses.
- Enter Mortgage Interest in Box 44: Report your total mortgage interest payments in Box 44, labelled “Residential property finance costs.”
HMRC will then automatically apply the 20% tax credit based on the information provided.
Key Considerations for Landlords in the New Tax Relief
If you’re a landlord with a mortgage on your rental property, you’ve likely felt the impact of the recent changes to mortgage interest tax relief.
These adjustments have left many landlords facing higher tax bills and questioning how to manage their rental income effectively.
Let’s break down the essential points you need to consider in this new era of mortgage interest tax credits:
- Incorporating Your Portfolio: If you have multiple properties or a substantial rental business, setting up a limited company to manage your investments could be beneficial. Within a company structure, mortgage interest can still be deducted as a business expense. However, this is a large decision with various implications, so professional guidance is essential.
- Increasing Pension Contributions: Boosting your pension contributions can help reduce your taxable income. The money you contribute to a registered pension scheme is tax-free up to certain limits, allowing you to save for the future while managing your current tax liability.
- Maximising Expense Claims: Ensure you’re claiming all eligible expenses associated with running your rental property. From agent fees and repairs to insurance premiums, many costs can be deducted from your rental income, helping to minimise your taxable profit and, consequently, your tax bill.
Remember, every landlord’s circumstances are unique, and what works for one property investor might not be optimal for another.
How Double Point Can Help
Let’s face it: taxes on rental income can be tricky. At Double Point, our team of skilled chartered accountants is ready to take the stress out of managing your rental property finances.
We provide comprehensive support for landlords, from filling out your Self Assessment tax return to identifying expenses you can claim and finding ways to optimise your tax strategy.
Our mission is to keep you in line with all of HMRC’s requirements while making sure you’re not paying a penny more in tax than you need to.
So whether you’re a seasoned property investor or just starting out on your landlord journey, we’ve got the knowledge and expertise to guide you through.
Why not book a consultation with us today? We’ll show you how we can help you conquer the world of mortgage interest tax relief and thrive as a landlord, no matter what changes come your way.
