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A Guide To Buy-to-Let Mortgage Interest Tax Relief

Financial Performance

Since April 2017, the system of calculating tax on rental income has changed significantly for landlords. By April 2020, landlords won’t be able to deduct mortgage expenses from rental income and will instead receive a new tax credit, which is much less generous than the old system.

Landlords Buy-To-Let Mortgage Interest Tax Relief Pre-2017

Historically, landlords purchasing property have opted for a buy-to-let mortgage, which can potentially cut a tax bill by thousands of pounds through tax relief.

Under the original system, landlords would only pay income tax on a net rental income. They would deduct the mortgage interest as well as any other expenses that were incurred throughout the year.

In practical terms, this meant that landlords could claim all of their mortgage repayments, only declaring rental income after making these payments. As an example, a landlord making £10,000 in rental income and paying £9,000 in mortgage interest payments would only pay tax on the £1,000 left after the mortgage payments were deducted.

Landlords Buy-To-Let Mortgage Interest Tax Relief 2017 – 2020

Since April 2017 however, the system has changed. It’s now harsher on landlords, with phased decreases in the percentage of mortgage payments that can be deducted from rental income and increases to the percentage of these mortgage repayments that qualify for a new 20% tax credit.

The government announced that these new mortgage rules would be implemented over a four-year period, falling each year until 0% in April 2020:

Tax Relief Table
Source: MoneySupermarket

Landlords Buy-To-Let Mortgage Interest Tax Relief – Post-2020

After April 2020, landlords will not be able to deduct any mortgage costs from their net rental income. Instead, all of the rental income will be taxable and a 20% tax credit will be provided. While this means landlords can cut their final tax bill by 20%, it’s still going to prove more expensive than the old system.

What’s initially less obvious is that these changes could also push you into a new tax bracket. The declared income that was used to pay the mortgage on your tax return could put you into the higher or additional-rate brackets depending on your current salary or pension.

So how can landlords prepare?

Cost management is part and parcel of running any successful property portfolio and enables landlords to make swift decisions to protect their investments. Once the tax relief deadline passes in 2020, there are a number of options landlords may want to consider in order to offset costs and ensure their investment remains profitable.

£Billions of tax relief before 2020

The most obvious answer is to review your finances. Keep in mind that you have a year left before the new system is fully implemented – giving you ample time to see where your portfolio stands and work out how the changes will affect you going forward.

There are still reliefs to be taken advantage of before the 2020 deadline, which will allow landlords to offset rental income expenses not only in the form of mortgage interest but other associated financial costs such as property repairs, various legal and management fees and rates, insurance and ground rents. Indeed, recent research indicates buy to let investors are still eligible to receive as much as £16.7bn worth of tax relief before the 2020 deadline, and £6.4 billion on interest rate costs alone after this date.

Limited Company Structure (Incorporation)

It’s important to note that these changes only affect private landlords. This has resulted in a larger number of people setting up their own limited company (otherwise known as incorporation) as a way of reducing the impact on their own portfolio.

While in theory, a company that owns the rental properties will still be able to deduct mortgage payments before declaring rental income, one drawback with this relates to reduced mortgage options as typically, fewer providers will lend to a company. What’s more, mortgage rates for businesses are more expensive than for private landlords, so it’s important to be aware of all the associated costs of going down this route before proceeding.

Additional charges

There could also be additional charges such as capital gains tax or an extra round of stamp duty that occurs when ownership is moved to the business. For some landlords, this can end up costing more than simply accepting the reduced tax relief.

The good news is that by investing through a company, the easiest way to pay yourself is via company dividends, which are taxed at a lower rate than a salary or pension. There are also tax-free dividend allowances that available that can extend how much you earn before you start paying tax.

Administrative obligations

Landlords with properties in limited companies should also prepare themselves for the inevitable administrative responsibilities.  As well as filing company tax returns, the company will need to produce annual accounts in a fixed, statutory format.

According to co-founder of quick house sale company Property Solvers, “Whilst buying properties within special purpose vehicles currently benefits from more favourable tax treatment, there are extra requirements that landlords are obliged to comply with.  Failure to do so could lead to fines as high as £1,500.”

He continues: “Fortunately, in the digital age we live in, it’s never been easier to digitise your processes.  Working with a financial professional will ensure that any challenges can be mitigated early.”

Rental costs

Passing the extra costs on to tenants in the form of rent rises is a further option to consider, though this won’t be appropriate for all, especially in areas where there is considerable competing inventory on the market and landlords will be mindful of not wanting to price themselves out of the market.

Transferring ownership

Finally, for investors with spouses who pay a lower rate of tax, there’s the option of transferring one or more properties to them. In order for this to be efficient, care, of course, needs to be taken to ensure this won’t take them into a higher tax band, thereby negating any obvious gains.

As with any investment decision, deciding how to proceed with the new deadline looming will require careful thought and investors unsure of the full implications should always seek professional assistance to ensure their portfolios remain in the strongest health for the new decade and beyond.


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