Changes to mortgage interest relief for buy to let investors

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While the UK government has been gradually reducing the portion of mortgage interest which is deductible against rental income (since 2017) many private landlords have not yet taken this into consideration. Unfortunately, this will have a major impact upon the tax returns of higher rate taxpayers where rental properties are held in their own name. Quite why this has not received more exposure is unclear but it is a fundamental change for private landlords.

Changes to mortgage interest relief

In the four tax years starting from 2017/18 there will be a gradual reduction in mortgage interest relief and a gradual introduction of the new basic rate tax allowance. Prior to the 2017/18 tax year a private landlord could deduct all mortgage interest (and other expenses) from rental income before applying any taxation charge. The new landscape is as follows:-

  • 2017/18 tax year - private landlords were able to deduct 75% of mortgage interest against rental income with relief on the remaining 25% of mortgage interest at the new basic rate tax allowance of 20%
  • 2018/19 tax year - the balance changes to 50%/50%
  • 2019/20 tax year - it will be 25%/75%
  • 2020/21 tax year - the old mortgage interest relief structure will disappear and mortgage interest will be deducted at a basic rate tax of 20%

At first glance it is difficult to see any major impact on the taxation of rental income but these two examples will perfectly illustrate the problem.

Example of new calculation

If we assume the following scenario, this will perfectly illustrate the difference in tax liabilities under the old system and the new system.

Rental income £15,000 per annum

Mortgage interest £7,000 per annum

Additional costs £2,000 per annum

Net rental income after expenses £6,000 per annum

Under the legislation prior to the 2017/18 tax year the net income for the private landlord would be £6000 and they would be charged accordingly:-

Basic rate taxpayer

20% x£6,000 = £1,200

Higher rate taxpayer

40% x £6,000 = £2,400

This is all very straightforward but once the new legislation is fully integrated it will be very different. There will be no mortgage interest relief as such and no opportunity to take into account financing costs against gross rental income. So, under the new legislation the same scenario would read as follows:

Rental income £15,000 per annum

Additional costs £2,000 per annum

Net rental income after expenses £13,000 per annum

As a consequence of the changes the rate of tax charged would be based upon the higher net rental figure of £13,000. It is only after the tax charge has been calculated that you can offset the standard 20% tax credit against mortgage interest. For example the future tax calculations in the same scenario would be:-

Basic rate taxpayer

20% x£13,000 = £2,600

Less the 20% tax credit against mortgage interest = £1,400

Total tax charge = £1,200

Higher rate taxpayer

40% x £13,000 = £5,200

Less the 20% tax credit against mortgage interest = £1,400

Total tax charge = £3,800

In the above scenario, a basic rate tax payer would pay the same level of tax but higher rate taxpayer would end up paying £1400 more than under the old structure. Interestingly, due to the way in which companies are structured, and the fact that the deduction of all costs is set in stone, it is still possible to deduct finance costs from gross income within a company – if your buy to let assets are held in a company wrapper.

Subtle but serious changes

On the surface the change in mortgage interest relief looks subtle but it is extremely damaging to the finances and the cash flow of higher rate taxpayers. It is almost as if the UK government would prefer the corporate sector to take over the UK buy to let industry - surely not?

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