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Tax on property and rental income

Buy-to-let mortgage tax relief changes explained

By Tom Wilson

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Buy-to-let mortgage tax relief changes explained

Starting in April 2017, landlords will start to lose valuable tax relief on their buy-to-let mortgage costs. We explain what the changes mean for you.

Many landlords have to borrow money – through a buy-to-let mortgage – to start building a rental property portfolio.

Historically, there’s been a major tax advantage if you have a buy-to-let mortgage – you only need to declare rental income after you’ve paid your mortgage, which cuts your tax bill by potentially thousands of pounds. 

But since April 2017, the way landlords have to declare their rental income has started to change, meaning most landlords will see their tax bills rise significantly.

This guide explains how buy-to-let mortgage tax relief is changing for landlords- and how much more you’ll need to pay.

  • Work out how much tax you owe with the jargon-free Which? Tax Calculator. It’s free to use, but there’s a £30 charge for non-members, if they want to submit their return to HMRC through the calculator.

Landlord buy-to-let mortgage tax relief in 2016-17

Under the old regime, landlords only pay income tax on their net rental income, or profits. In other words, after you have deducted the interest from the mortgage you have on your rental property, as well as any other expenses you've incurred throughout the year.

Remember, only mortgage interest is deductible from your rental income. The majority of landlords have interest-only mortgages, which means in practice they can claim all of their mortgage repayments.

If you have a repayment mortgage, whereby you're repaying the capital you've borrowed and the interest, you can't claim the capital-repayment element.

To see how this works, consider a landlord that charges £950 per month rental income, with mortgage interest payments of £600 per month.

  • They earn rental income of £11,400 for the year
  • They pay mortgage interest of £7,200 for the year
  • Their taxable income is £4,200 (£11,400 - £7,200).
  • A basic-rate taxpayer would pay £840 in tax
  • A higher-rate taxpayer would pay £1,680 in tax

These rules are still in place until April 2017, so you’ll still get full relief on your mortgage payments when you file your 2016-17 tax return (which needs to be submitted by 31 January 2018).

Landlord buy-to-let mortgage tax relief in 2017, 2018 and 2019

From April 2017, the way you calculate your tax bill on rental income is changing, and by April 2020, you won't be able to deduct all of your mortgage expenses from your rental income to reduce your tax bill.

Instead, you'll get a new tax credit, which is less generous than the current regime. We've explained this below.

The government has decided to phase in the new mortgage interest rules over a four year period. You'll see the amount of mortgage interest tax relief steadily falling each year:

  • In 2017-18, you can claim 75% of your mortgage tax relief
  • In 2018-19, you can claim 50% of your mortgage tax relief
  • In 2019-20, you can claim 25% of your mortgage tax relief

The table below shows how this will impact on a higher-rate taxpaying landlord receiving £950 rent a month and paying £600 towards their mortgage.  

Mortgage tax relief for property with £950 rent and £600 mortgage per month
Tax year Proportion of mortgage interest deductible under previous system Proportion of mortgage interest qualifying for 20% tax credit under new system Tax bill Post-tax and mortgage rental income
Prior to April 2017 100% 0% £1,680 £2,520
2017-18 75% 25% £2,040 £2,160
2018-19 50% 50% £2,400 £1,800
2019-20 75% 25% £2,760 £1,440
2019-20 0% 100% £3,120 £1,080

 

Landlord buy-to-let mortgage tax relief in April 2020

From April 2020, landlords will no longer be able to deduct their mortgage costs from their rental income.

All of the rental income you earn will be taxable, and you'll instead receive a 20% tax credit for your mortgage interest. This means you can cut your final tax bill by 20% of your interest.

To work this out, simply multiply the mortgage interest you pay by 20%.

This new system will potentially increase your tax bill in two ways.

If you're a higher or additional-rate taxpayer, you won't get all the tax back on your mortgage repayments, as the credit only refunds tax at the basic 20% rate, rather than the top rate of tax paid.

Less obviously, you could also be forced into a higher tax bracket because you’ll need to declare the income that was used to pay the mortgage on your tax return.

This could push your total income into the higher (£45,000 in 2017-18) or additional-rate (£150,000) tax brackets, depending on your income from other sources, such as your salary or pension.

Landlord buy-to-let tax relief in 2020: an example

Going back to our example of a landlord that charges £950 per month rental income, with mortgage interest payments of £600 per month.

  • They'll pay tax on the full £11,400 rental income they earn
  • They'll still pay £7,200 in mortgage interest
  • They'll get a tax credit of £1,440 (£7,200 x 20%)
  • A basic-rate taxpayer will pay £840 - no increase
  • A higher-rate taxpayer will pay £3,120 - double the tax

The chart below shows how this is calculated.

Can landlords incorporate to keep their mortgage relief?

This change in tax relief only affects private landlords - people who own their properties as individuals (or couples), rather than through a business.

In theory, by setting up a business that owns their rental properties, landlords will be able to continue to declare rental income after deducting the mortgage.

However, if you’re considering doing this is vital to research it thoroughly, as even with this tax saving you could end up far worse off.

There are a few reasons for this, but the main one is that mortgage rates for businesses are more expensive than for private landlords, which could cost more than you’d save in higher tax relief.

You'd also need to pay an extra round of stamp duty when you transfer ownership of the property to the business. You can use our calculator to work out your buy-to-let stamp duty bill.

 


Finally, if you incorporate your taxes will become more complex. Instead of paying income tax on your rental income, you'll need to file taxes for your business, and pay corporation tax on your profits.

To receive the rental income yourself, you'll need to pay a dividend. This will be taxed as income, but at a lower rate.

You can find out more in our guide to dividend tax.  

  • Last updated: May 2017
  • Updated by: Tom Wilson
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