Impact of Mortgage Cost Allowance Restrictions on Landlords

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

Historic tax relief

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.

New buy-to-let rules

Since the start of the 2017-18 tax year, though, the new buy-to-let tax system has started to be 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 bracketTax bill on £10,000 annual rental incomeTax relief (20% of £9,000 mortgage interest payments)Total tax bill before April 2017Total tax bill in 2020

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.

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.

Key changes

While landlords could find themselves paying more tax on their rental income, there are other changes that could take place because of the new rules:

  • 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 – meaning that they could be losing money.

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 company as a result 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, it can be useful to 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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