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Buy-to-let mortgage interest tax relief explained

Under new rules being phased in over the next few years, landlords will progressively lose valuable tax relief on their buy-to-let mortgage costs. We explain what the changes mean for you.

In this article
What is buy-to-let mortgage interest tax relief?   Landlord mortgage interest tax relief in 2018-19 Why the tax credit is bad news for landlords
Can landlords incorporate to keep their mortgage interest relief? Landlord mortgage interest tax relief before 2017 Get expert buy-to-let mortgage advice

What is buy-to-let mortgage interest tax relief?

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 will see their tax bills rise significantly.

Our video explains how buy-to-let mortgage tax relief has changed for landlords- and what it means for your tax bill. 

 

 

    Landlord mortgage interest tax relief in 2018-19

    Since April 2017, tax relief on mortgage interest has been gradually phased out. By April 2020, you won't be able to deduct any of your mortgage expenses from rental income to reduce your tax bill.

    Instead, you'll receive a tax-credit, based on 20% of your mortgage interest payments. This is less generous for higher-rate taxpayers, who effectively received 40% tax relief on mortgage payments under the old rules.

    The new system is being phased in over several years.

    In 2019-20, you can deduct one quarter of your rental income, while three quarters of your mortgage interest payments will receive the tax credit.

    As of April 2020, all mortgage interest will only receive the tax credit.

    For previous years: 

    • In the 2017-18 tax year, you could claim 75% of your mortgage tax relief
    • In the 2018-19 tax year, you could claim 50% 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 25% 75% £2,760 £1,440
    From April 2020 0% 100% £3,120 £1,080
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    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 (£50,000 in 2019-20) or additional-rate (£150,000) tax brackets, depending on your income from other sources, such as your salary or pension.

    Mortgage interest 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 interest 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, you'll need to pay yourself a dividend. This will be taxed as income, but at a lower rate than if you'd received the income directly.

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

    Landlord mortgage interest tax relief before 2017

    Under the old regime, you would only pay income tax on your net rental income, or profits. In other words, you'd first deduct the interest from the mortgage on your rental property, as well as any other expenses incurred throughout the year.

    With the majority of landlords being on interest-only mortgages, this meant that in practice they could claim all of their mortgage repayments.

    For a landlord charging £950 per month rental income, and with mortgage interest payments of £600 per month, it worked like this:

    • 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 (20% of £4,200).
    • A higher-rate taxpayer would pay £1,680 in tax (40% of £4,200).

    Get expert buy-to-let mortgage advice

    Before taking out a buy-to-let mortgage, it can be helpful to talk to a professional adviser. For impartial advice on the best mortgage for you from an expert who doesn't work on commission, call  Which? Mortgage Advisers on 0800 197 8461 or request a free call back using the form below.

    If you'd like to talk to an expert adviser about your mortgage options, complete your details and Which? Mortgage Advisers will give you a free call back.

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    Correct as of date of publication.


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