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Mortgage Interest Tax Relief – Implications of the Change

Published by Susan Basnet
Posted Date: June 11, 2024 , Modified Date: June 11, 2024
Categories: Landlords, Tax Relief

You might think that mortgage interest payment qualifies as a deductible expense for tax purposes since they are a part of your business expenses. However, HMRC no longer agrees with this viewpoint. This shift took effect in April 2017. Let's explore the impact of this change on landlords in the UK.

Background - Mortgage Interest Tax Relief

Before 6 April 2017, individual buy-to-let landlords could fully deduct their mortgage interest from their rental income. However, following the HMRC's announcement of the change in April 2017, landlords can no longer deduct all their finance costs from their property income to calculate their taxable profits. Instead, a basic rate reduction from their income tax liability is provided to landlords.

Landlords could still deduct 75% of the finance costs in 2017, 50% in 2018, and 25% in 2019, claiming 20% relief on the remaining percentage. However, the deduction was removed entirely from April 2020.

The Basic Working Mechanism

The buy-to-let mortgage interest tax relief, often referred to as mortgage interest tax relief, is a tax credit available to landlords. This relief allows landlords to reduce their tax liability based on a specified amount. The eligible deduction is calculated at 20% of the lower of the following:

  • Finance costs - i.e., the costs not deducted from rental income in the current year.
  • Property business profits - i.e., the profits of the property business in the tax year, after accounting for any losses carried forward.
  • Adjusted total income - i.e., the individual's total income minus the personal allowance.

The restriction is put in place to ensure that the reduction is not used to create a tax refund. The next section contains a few examples incorporating these restrictions.

Practical Examples – In-depth Analysis

Let's understand the mechanism of the relief in detail, as well as the cases where the relief may be restricted, with a few examples.

Example 1 - When the finance cost exceeds property business profits

Let's visit Mr Henry's situation to understand the procedure for computing the BTL mortgage relief. In the tax year 2023/24, Mr Henry earns a profit of £20,000 from his buy-to-let business but incurs £30,000 a year in mortgage interest. Additionally, he has an employment income of £25,000. His income tax can be calculated as follows:

First, let's translate these figures into numbers:

  • Finance costs - £30,000
  • Property business profits - £20,000
  • Adjusted total income - £32,430 (20,000+25,000-12,570)

In this instance, the lower of the three figures is the property business profits (£20,000). Therefore, the mortgage relief will be restricted to 20% of the property business profits. Consequently, his income tax liability would be calculated as follows:

Particulars

Amount (£)

Employment income

25,000

Property income

20,000

Less: personal allowance

(12,570)

Taxable Income

32,430

Income tax liability (32,430@ 20%)

6,486

Less: Mortgage interest tax relief (20% of £20,000)

(4,000)

Income tax payable

2,486

Therefore, Mr Henry is liable to settle an income tax amount to £2,486.

Example 2 - When the adjusted total income is less than the finance costs

In the year 2024/25, Mr Henry left his employment, making the property income his sole income source. However, the mortgage interest and the property business profits remain the same.

Again, let's translate these figures into numbers:

  • Finance costs - £30,000
  • Property business profits - £20,000
  • Adjusted total income - £7,430 (20,000-12,570)

In this instance, the lower of the three figures is the Adjusted total income (£7,430). Therefore, the mortgage relief will be restricted to 20% of the adjusted total income. Here's how the income tax liability would change as a result of the change in the scenario:

Particulars

Amount (£)

Employment income

0

Property income

20,000

Less: personal allowance

(12,570)

Taxable Income

7,430

Income tax liability (7,430@ 20%)

1,486

Less: Mortgage interest tax relief (20% of £7,430)

(1,486)

Income tax payable

Nil

As a result of the reduction in Mr Henry's total income, his income tax liability, along with the mortgage interest tax relief, has fallen from our previous scenario.

It's crucial to understand that the Buy-to-Let mortgage interest tax relief applies exclusively to individual landlords and those in partnerships. Companies and Furnished Holiday Lettings (FHL) can still fully deduct their mortgage interest payments from their earnings. However, the spring budget 2024 announced the abolition of the Furnished Holiday Letting (FHL) tax regime starting from April 2025, restricting full mortgage interest deductions to companies only.

This may prompt consideration of incorporating your business. However, weighing several factors before making such a significant decision is essential. For instance, the transfer of property ownership to a company's name may incur Stamp Duty Land Tax (SDLT). Additionally, companies are subject to corporation tax, and the filing and payment requirements differ significantly from those for individuals.

For a more detailed analysis of the pros and cons of running a buy-to-let business as a company, read our article incorporating properties into a limited company.

Conclusion

In conclusion, the landscape of mortgage interest tax relief for buy-to-let landlords has undergone a significant transformation in recent years. The transition from full deductibility to a basic rate reduction has prompted landlords to reconsider their financial strategies and evaluate the impact on their tax liabilities.

In the ever-evolving landscape of property taxation, staying informed and seeking professional guidance is crucial in making sound decisions for your buy-to-let business. Stay updated on legislative changes, seek advice from experts, and adjust your strategies to ensure optimal financial efficiency in a dynamic and challenging market.

Need expert advice on mortgage interest tax relief ?

Contact us today for efficient and hassle-free assistance.

Susan Basnet
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