Navigating the world of buy-to-let properties can be complex, especially with recent changes to mortgage tax relief. Here’s a breakdown of what you need to know to stay informed and make the best financial decisions.
What is Buy-to-Let Mortgage Tax Relief?
Buy-to-let mortgage tax relief allowed landlords to deduct mortgage interest payments from their rental income before calculating their tax liability. This effectively reduced the amount of tax landlords had to pay.
The Changes Explained
The government has phased out this relief, replacing it with a tax credit system. Here’s how it works:
- Phased Reduction: From April 2017 to April 2020, the amount of mortgage interest landlords could deduct gradually decreased. By April 2020, landlords could no longer deduct any mortgage interest from their rental income.
- Tax Credit Introduction: Instead of deducting mortgage interest, landlords now receive a tax credit worth 20% of their mortgage interest payments. This change primarily affects higher-rate taxpayers, who previously benefited from higher relief rates. The new system means higher or additional-rate taxpayers can no longer claim the tax back on their mortgage repayments, as the credit only refunds tax at the basic 20% rate, rather than the top rate of tax paid.
Impact on Landlords
These changes have significant implications for landlords:
- Higher Tax Bills: Landlords in higher tax brackets may see an increase in their tax bills, as they can no longer deduct mortgage interest at their marginal tax rate.
- Potential for Higher Tax Brackets: The new rules could force some landlords into a higher tax bracket, as they’ll need to declare the income used to pay the mortgage on their tax return. This could push their total income into the higher or additional-rate tax brackets, depending on their income from other sources, such as salary or pension.
- Profitability: The profitability of buy-to-let investments may decrease, prompting some landlords to reassess their portfolios.
- Strategic Adjustments: Landlords might consider strategies such as forming limited companies to manage their properties, as corporate entities are still able to deduct mortgage interest as a business expense.
Mortgage Interest Tax Relief in 2024-25: An Example
Assuming a landlord takes in £650 per month rental income and makes mortgage interest payments of £300 per month:
- They’ll pay tax on the full £7,800 annual rental income they earn.
- They’ll pay £3,600 in mortgage interest.
- They’ll get a tax credit of £720 (£3,600 x 20%).
- A basic-rate taxpayer will pay £840 – no increase compared to the old rules.
- A higher-rate taxpayer with 40% tax bracket will pay £2,400.
What Should Landlords Do?
To navigate these changes effectively, landlords should:
- Review Finances: Assess the impact of the tax relief changes on your rental income and overall profitability.
- Seek Professional Advice: Consult with a tax advisor to explore options and strategies tailored to your situation.
- Consider Restructuring: Evaluate whether restructuring your property ownership, such as through a limited company, could offer tax advantages. By setting up a business that owns their rental properties, landlords will be able to continue to declare rental income after deducting the mortgage. However, it’s vital to research this thoroughly, as even with this tax saving, you could end up far worse off. Mortgage rates, legal fees, and annual accountants’ fees for businesses are often more expensive than for private landlords, which could cost more than you’d save in higher tax relief. If you incorporate, your taxes will become more complex. Instead of paying income tax on your rental income, you’ll need to file taxes for your business and pay corporation tax on your profits. To receive the rental income, you’ll need to pay yourself a dividend, which will be taxed as income.
The FCA does not regulate some forms of Buy-to-Let mortgages and Tax planning, and we act as introducers for Tax planning.
This information is correct as of August 2024.