Under new rules being phased in over the next few years, landlords will progressively lose valuable tax relief on their buy-to-let mortgage costs. Below the changes have been outlined to explain why.
Many landlords have to borrow money through a but-to-let mortgage in order to start building a rental property portfolio.
There has been a historical major tax advantage if you have a buy-to-let mortgage, as you only need to declare rental income after you’ve paid your mortgage, which cuts your tax bill by potentially thousands of pounds.
However, since April 2017, the way landlords have to declare their rental income has started to change, meaning most will see their tax bills increase significantly.
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The old system meant that you would only pay income tax on your net rental income, or profits. In other words, you'd first deduct the interest from the mortgage on your rental property, as well as other expenses incurred throughout the year.
With the majority of landlords being on interest only mortgages, this meant that in practice they could claim all of their mortgage repayments.
For a landlord charging £1000 per month rental income, and with mortgage interest payments of £650 per month, it worked like this:
Since April 2017, the system of calculating tax bills on rental income has changed, and by April 2020, you won't be able to deduct all of your mortgage expenses from rental income to reduce your tax bill.
Now landlords will be given a new tax credit, which is less generous than the current system. This is outlined below.
The government has decided to phase in the new rules over a four-year period. You'll see straight away the amount of mortgage interest tax relief steadily falling each year:
The table below shows how this will impact on a higher-rate taxpaying landlord receiving £1000 rent a month and paying £650 towards their mortgage.
Mortgage tax relief for property with £1000 rent and £650 mortgage per month | |||||
Tax year | Proportion of mortgage interest deductible under previous system | Proportion of mortgage interest qualifying for 20% tax credit under new system | Tax bill | Post-tax and mortgage rental income | |
Prior to April 2017 | 100% | 0% | £1,680 | £2,520 | |
2017-18 | 75% | 25% | £2,040 | £2,160 | |
2018-19 | 50% | 50% | £2,400 | £1,800 | |
2019-20 | 25% | 75% | £2,760 | £1,440 | |
From April 2020 | 0% | 100% | £3,120 | £1,080 |
From April 2020, landlords will no longer be able to deduct their mortgage costs from their rental income.
All of the rental income you earn will be taxable, and you'll instead receive a 20% tax credit for your mortgage interest. This means you can cut your final tax bill by 20% of your interest.
To work this out, simply multiply the mortgage interest you pay by 20%.
This new system will potentially increase your tax bill in the following two ways:
This could potentially push your total income into the higher (£45,000 in 2017-18) or additional-rate (£150,000) tax brackets, depending on your income from other sources, such as your salary or pension.
Using the example of a landlord that charges £1000 per month rental income, with mortgage interest payments of £650 per month.
This change in tax relief only affects private landlords, people who own their properties as individuals (or couples), rather than through a business.
In theory, by setting up a business that owns their rental properties, landlords will be able to continue to declare rental income after deducting the mortgage. If you’re considering doing this is vital to research it thoroughly, as even with this tax saving you could end up far worse off. The main reasons for this are:
To receive the rental income yourself, you'll need to pay a dividend. This will be taxed as income, but at a lower rate.