Explained: Buy to let mortgage interest tax relief
Posted on 21st January 2021 at 12:56
Due to new rules brought in as of April 2020, landlords will increasingly lose valuable tax relief on the costs of their buy-to-let mortgages.
Traditionally, landlords could deduct all their mortgage interest from the rental income they received to calculate the profit or taxable income. This meant that the landlord was effectively getting relief from paying tax on the mortgage interest amount. This is known as mortgage interest tax relief.
However, since April 2017, the way in which landlords have to declare their rental income has changed so most will see a significant increase in their tax bills. It used to be a major tax advantage to borrow through a buy-to-let mortgage, this is no longer the case.
How is buy-to-let income taxed?
Buy-to-let owners must declare the income they receive in rent on their personal (self-assessment) tax return each year.
As a reminder, the personal tax year ends on 5 April and you have until the following 31 January to submit your return and pay any tax due. If you are not already registered for self-assessment but start receiving rental income, you must register for self-assessment.
What has changed?
Tax relief is now a flat rate of 20%. If a landlord pays a basic tax rate then they will see no change. However, those on higher incomes will lose a lot more in mortgage interest payments.
Estimated figures published by the Nationwide Building Society show how a landlord’s profit may be affected. A landlord with a £150,000 buy-to-let mortgage on a property that is worth £200,000, with rental income of £800 a month, would previously have had a net profit of £2,160 per year. Now, with the new system in place, that profit would drop to £960.
Ways to deal with the loss of buy-to-let tax relief
One obvious, but less than ideal solution, would be to increase the rent so that the extra cost is then passed on to the tenant. However, the majority of tenants are paying the maximum they can afford and the landlord would also be pricing themselves out of the market.
There are a few other options to try:
Switching to a shorter term, fixed-rate mortgage with lower interest rates, but there are higher risks associated with these type of mortgages.
The landlord could place their property portfolio into a limited company structure. One drawback is that the mortgage options will be less as a lot of mortgage providers won’t lend to a company. Also, by doing it this way, the taxes will become more complex. Instead of paying income tax on the rental income, the landlord would need to file taxes for their business, and pay corporation tax (which is lower) instead of income tax on their profits. To receive the rental income, they would need to pay themselves a dividend. This would be taxed as income, but at a lower rate than if the income had been directly received.
If the landlord has a spouse who pays a lower tax rate, then the ownership could be transferred to them of one or more properties. Providing that this doesn’t then take them into a higher tax band.
For more information or advice about your buy to let mortgage, feel free to book a call in with us to discuss your requirements - we'd love to hear from you.
Nicola J Sorrell -
Founder | Xero Champion | IR35 Expert
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