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31 Mar 2018

Mortgage tax relief changes for buy-to-let landlords set to come into force

Landlords' 2017-18 tax returns will be the first to fall under new regulations

Landlords are braced for cuts to their profits as the government's mortgage interest tax relief changes are phased in from next week.

Originally announced in the 2015 Budget, the rules mean that when landlords file their tax returns for the 2017-18 tax year, the amount of mortgage interest they can offset against their tax bill will be reduced.

With this figure set to drop each tax year until it's fully replaced by a tax credit for mortgage interest in 2020-21, investors could see thousands of pounds of potential profits wiped out.

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What is mortgage interest tax relief?

Until April 2017, landlords could deduct all of their mortgage interest payments before calculating their tax bill, meaning they would be taxed on their profits rather than their overall turnover.

With the majority of landlords being oninterest-only mortgages, this meant the savings on offer could be significant.

This is set to change, though. When investors file their returns for the 2017-18 tax year, due by 31 January 2019, they will only be able to claim tax relief on 75% of their mortgage interest. They will get a 20% tax credit on the rest of their mortgage interest payments.

In the following year, the relief will only be available on half of their interest, and they'll get the 20% credit on the rest.

The short video below explains the basics of mortgage interest tax relief:

Mortgage interest tax relief changes explained

From the April 2020-2021 tax year, mortgage interest tax relief will be fully replaced by a tax credit limited to the basic rate of tax (20%).

For a higher-rate taxpayer, the tax credit is roughly half as generous. But it could be more punishing still, as it forces landlords to declare a higher income - which could push them into a higher tax bracket.

This threatens to wipe out profits for higher-rate taxpayers, and could mean some basic-rate taxpayers are pushed into the higher band.

The table below shows how landlords will need to claim tax relief on their mortgage costs as the new rules phase in:

Tax yearMortgage interest deductible under old systemMortgage interest qualifying for 20% tax credit under new system
2017-18 (filed by 31 Jan 2019)75%25%
2018-19 (filed by 31 Jan 2020)50%50%
2019-20 (filed by 31 Jan 2021)25%75%
2020-21 onwards0%100%

Mortgage interest tax relief changes for higher-rate taxpayers

The table below shows the extent to which landlords who are higher-rate taxpayers could be affected by the changes.

In this example, we take a landlord who receives £950 a month in rent and pays £600 a month towards their mortgage.

Before the 2017-18 tax year, this landlord would have made a profit of £2,520 a year, but as the tax credit is phased in, their taxes rise and their profits fall. By 2020-21, this profit will be reduced by nearly 60%, to just £1,080.

Tax yearTax billProfit
2017-18 (filed by 31 Jan 2019)£2,040£2,160
2018-19 (filed by 31 Jan 2020)£2,400£1,800
2019-20 (filed by 31 Jan 2021)£2,760£1,440
2020-21 onwards£3,120£1,080

Should landlords set up a limited company?

As they seek to counter taxation changes, some landlords have set up limited companies for their investment properties.

Indeed, the specialist broker Kent Reliance claims that 70% of buy-to-let mortgage applications in the first nine months of 2017 were made via limited companies, up from 45% in 2016.

While setting up a company will help you avoid tax relief changes, it's certainly not the right move for everyone.

When we assessed the pros and cons of setting up a limited company last autumn, we found that for many landlords the potential tax savings were offset by significantly higher mortgage rates and the prospect of triggering additional stamp duty surcharges and capital gains tax bills.

Is investing in property still profitable?

For many investors, buy-to-let has become a less profitable business in the last few years, as government and Bank of England interventions on tax and lending have cooled the sector.

Research published by the Intermediary Mortgage Lenders Association showed that buy-to-let investment dropped by a remarkable 80% between 2015 and 2017, as investors decided against expanding their property portfolios.

And while it is still possible to make a return from property in 2018, there are some other changes you'll need to be aware of, including:

You can find out more about the challenges facing landlords in our full story on 12 things buy-to-let landlords need to know in 2018.