Changes to Mortgage Tax Relief – problematic for Landlords?

4th June 2019

Before the changes to mortgage tax relief happened in 2017, buy-to-let landlords were able to deduct any mortgage interest (plus additional associated costs) along with other costs before determining taxable profit. You would then be taxed on that profit at your marginal rate e.g. 20% basic rate, 40% higher rate and 45% additional rate. So, how will this affect landlords over the next few years? 

There will be an incremental decrease in the amount of mortgage interest you can deduct from your rental income before submitting your taxes. From 2017 until 2020 there will be a deduction of 25% each year until eventually, you will no longer be able to deduct and mortgage interest from your rental income. 

The new rules – what has actually changed? 

When the government have fully rolled out the new rules (April 2020), landlords will no longer be able to deduct mortgage interest costs from taxable profits (if the property is owned by an individual, in other words privately). Until 2020 there is an incremental decrease in the amount of mortgage tax relief you can claim back on your annual rental income. 

The rules only apply to those who own properties privately, properties owned by companies can continue under the old rules. Meaning you could technically register yourself as a business and continue to declare rental income after deducting the mortgage. However, business costs are considerably higher than personal costs and you could end up paying more than you saved. 

From April 2020, buy-to-let landlords will only be able to claim a basic rate allowance – which will be irrespective of any marginal rate. However this change isn’t just happening overnight, the new rules are being phased in over four years

Mortgage Tax Relief – Timeline of changes 

Before 2017: 

  • Mortgage interest charges could be offset against rental income. 
  • This was great for saving opportunities e.g. if a buy-to-let landlord had an annual rental income of £27,000 and an annual mortgage interest of £22,000 they would only need to pay tax on the remaining £5000 at the usual rate. 

Tax year 2017/18: 

  • Landlords could only deduct 75% of the total amount of mortgage interest. 
  • At the same time a 20% tax credit was introduced, which could be applied to the 25% of annual mortgage interest which couldn’t be offset against rental income. 

Example: 

 A landlord charges £1000 per month rental income, with mortgage interest payments of £500 per month. 

£12,000 Rental Income 

£6,000 Mortgage Interest (25% eligible for 20% Tax Credit)  

£6,000 Taxable Income (Rental income MINUS Mortgage interest) 

Basic rate tax payers will pay £900 in tax (20% of £6000 Taxable income MINUS Tax Credit) 

Higher rate tax payers will pay £2,100 in tax (40% of £6000 Taxable income MINUS Tax Credit) 

Additional rate tax payers will pay £2,400 in tax (45% of £6000 Taxable income MINUS Tax Credit) 

Tax year 2018/19: 

  • Landlords will only be able to offset 50% of mortgage interest against rental income. 
  • 50% qualifying for the new 20% tax credit. 

Example: 

 A landlord charges £1000 per month rental income, with mortgage interest payments of £500 per month. 

£12,000 Rental Income 

£6,000 Mortgage Interest (50% eligible for 20% Tax Credit) 

£600 Tax Credit 

£9,000 Taxable Income (Rental income MINUS Mortgage interest) 

Basic rate tax payers will pay £1,200 in tax (20% of £9000 Taxable income MINUS Tax credit) 

Higher rate tax payers will pay £3,000 in tax (40% of £9000 Taxable income MINUS Tax Credit) 

Additional rate tax payers will pay £3,450 in tax (45% of £9000 Taxable income MINUS Tax Credit) 

Tax year 2019/20: 

  • Landlords will only be able to offset 25% of mortgage interest against rental income. 
  • 75% qualifying for the new 20% tax credit. 

Example: 

 A landlord charges £1000 per month rental income, with mortgage interest payments of £500 per month. 

£12,000 Rental Income 

£6,000 Mortgage Interest (75% eligible for 20% Tax Credit)  

£10,500 Taxable Income (Rental income MINUS Mortgage interest) 

Basic rate tax payers will pay £1,200 in tax (20% of £10,500 Taxable income MINUS tax Credit) 

Higher rate tax payers will pay £3,300 in tax (40% of £10,500 Taxable income Minus Tax Credit) 

Additional rate tax payers will pay £3,825 in tax (45% of £10,500 Taxable income MINUS Tax Credit) 

Tax year 2020/21: 

  • Landlords won’t be able to offset a % of mortgage interest against rental income.  
  • All mortgage interest will qualify for 20% tax credit. 

Example: 

 A landlord charges £1000 per month rental income, with mortgage interest payments of £500 per month. 

£12,000 Rental Income 

£6,000 Mortgage Interest (100% eligible for 20% Tax Credit) 

£12,000 Taxable Income (Rental income MINUS Mortgage interest) 

Basic rate tax payers will pay £1,200 in tax (20% of £12000 Taxable income MINUS Tax Credit) 

Higher rate tax payers will pay £3,600 in tax (40% of £12000 Taxable income MINUS Tax Credit) 

Additional rate tax payers will pay £4,200 in tax (45% of £12000 Taxable income MINUS Tax Credit) 

Consequences of the changes 

As a consequence of the changes a substantial number of landlords have been caught out by these new rules, as they are getting much bigger tax bills. This is forcing some landlords to sell up as it’s not worth it. Especially if they are in full time work and earn a decent salary, as this puts them into a higher tax rate. 

Some of the other consequences to come from the changes are:  

  • Bigger Tax liabilities 
  • Increase income to a level that will impact Child Benefit Tax Charge 
  • Could Push you over the threshold for Personal Allowance 
  • Buy to Let becomes a burden and not a profit generator 

What can you do about these changes? 

Don’t panic! Yes, it doesn’t sound great but work out how badly you will be affected. There may be some properties in your portfolio that are worth it and some that aren’t. The mortgage tax relief changes will affect every person differently, depending on other external factors. 

If you are in this situation, consider: 

  • Set up a company and sell your properties (may have to pay stamp duty twice) 
  • Sell properties that aren’t profitable 
  • Attempt to cut costs to offset the extra tax 
  • Transfer part ownership to your spouse -spread income and tax? 
  • Partnerships take ownership of the properties 
  • Claim as many Capital allowances as you can 
  • Use domestic items relief 

If you are still unsure about how you will be affected all buy to let information can be found here

Making Tax Digital  

As it’s now more complicated than ever to calculate the allowable costs on a rental property leaving it to your accountant to get it right might be the best option. Now that Making Tax Digital is in effect, more people are trying to handle tax themselves with online programmes or apps and making mistakes. Thus, meaning that the HMRC will be more vigilant towards companies making these mistakes, and nobody wants that. 

Tax Investigation Insurance 

Landlords who rent out properties for buy-to-let often do their own tax returns and easily make mistakes. So, how do you get around this? 

Ideally, we would recommend outsourcing, however, if you prefer to do your own tax returns, we highly recommend getting insurance. Insurance is difficult enough, so if you need more information on how you can protect your business with insurance click here. 

In conclusion, there are big changes underway and it is going to affect each private landlord differently. Be sure to check how you are going to be affected under this new legislation and make your decisions accordingly. If you are going to start up a business to take ownership of your properties, make sure you thoroughly research before going ahead with it. You may end up paying more than if you stayed private. Finally, if you do not feel comfortable with the new calculations of your tax then we are here to help. Fill in your details in the form below and we will be in touch. 

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