Is Mortgage Interest Tax Deductible in the UK?

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Revisions in tax relief regulations are resulting in increased bills for certain landlords. Here, we elucidate the implications of these changes for you.

Landlords now face increased tax bills due to changes in how rental income is reported. Previously, utilizing buy-to-let mortgages offered tax advantages, but recent reforms have altered this landscape. This guide outlines these changes and their impact on landlords’ tax liabilities.

Landlord mortgage interest tax relief in 2022-23

As of April 2020, landlords can no longer deduct mortgage expenses from rental income to lower their tax burden. Instead, they receive a tax credit equivalent to 20% of mortgage interest payments. This change is less advantageous, especially for higher-rate taxpayers who previously received 40% tax relief on mortgage payments.

The new system has been phased in since 2017. This means landlords have gradually faced the impact of reduced tax benefits over the years. With the complete elimination of mortgage interest deductions in 2020, landlords need to reassess their financial strategies to adapt to the new tax regime.

Overall, these changes have significant implications for landlords, impacting their financial calculations and bottom line. Understanding the evolving tax landscape is crucial for landlords to navigate the complexities and optimize their investment strategies accordingly.

Why the tax credit is bad news for landlords

Under the new system, higher or additional-rate taxpayers can no longer seek tax relief on their mortgage repayments. Instead, the tax credit refunds only at the basic 20% rate, unlike the previous regime that offered relief at the top tax rate.

Additionally, the new rules might inadvertently place some landlords into a higher tax bracket. This occurs because landlords must now declare the income used to cover mortgage payments on their tax returns. Consequently, this inclusion of rental income could elevate their total income, potentially pushing them into higher tax brackets based on other income sources, such as salary or pension.

Mortgage interest tax relief in 2023: an example

Let’s break down the numbers:

If a landlord earns £950 per month in rental income and pays £600 monthly towards mortgage interest:
They’ll be taxed on the entire £11,400 rental income.
With £7,200 going towards mortgage interest, they’ll receive a tax credit of £1,440 (calculated at 20% of £7,200).
For a basic-rate taxpayer, this means paying £840, which remains unchanged from the previous rules.
However, for a higher-rate taxpayer, the tax bill increases to £3,120, double the amount compared to the old system.

Can landlords incorporate to keep their mortgage interest relief?

This change in tax relief primarily impacts individual landlords, not those who own properties through a business entity. While forming a business to own rental properties may allow landlords to continue deducting mortgage interest from rental income, thorough research is essential as this strategy may not always result in financial gains.

There are several considerations to weigh. Firstly, business mortgage rates tend to be higher than those for individual landlords, potentially negating any tax savings. Additionally, transferring property ownership to a business incurs additional stamp duty costs, which should be factored into your financial analysis.

Incorporating your rental activities also introduces greater tax complexity. Instead of paying income tax on rental income, you’ll need to navigate corporate tax requirements and possibly pay yourself dividends, which are taxed at a lower rate than direct income but still require careful planning.