Mortgage Tax Relief

Mortgage Tax Relief

Landlords with rental properties could be hit with an increase in tax liabilities as restrictions to mortgage tax relief is gradually introduced. Those landlords with property portfolios which have large mortgages and who are higher rate tax payers will suffer the most.

Mortgage tax relief is on interest not capital

The first thing to mention is that tax relief is only available on the interest part of the mortgage repayment.

Mortgage and loan repayments can be split into 2 parts. The first part is reducing the capital so that the mortgage or loan is reducing in value. The second part is paying the interest on the outstanding balance.

It is only the latter part which has ever been tax deductible.

So, if your rental property has mortgage repayments of £500 a month, it does not mean that you can deduct £6,000 per annum from your rental income to calculate rental profits. You must therefore find out how much of the £6,000 related to capital and how much was interest. Only the interest value is tax deductible.

What were the old rules on mortgage tax relief?

Mortgage interest pre April 2017 received full tax relief. It was treated like any other tax deductible expense and reduced the profits accordingly.

For example, if a portfolio of rental properties had income of £50,000, with mortgage interest of £15,000, and other tax deductible expenses of £5,000, then the rental profits are £30,000. Tax was calculated on £30,000 without any restrictions.

A basic rate tax payer would then pay tax at a rate of 20% on the £30,000 profits.

Whilst a higher rate tax payer would then pay tax at a rate of 40% on the £30,000 profits.

What are the new rules on mortgage tax relief?

From April 2020 mortgage tax relief will be restricted to the basic rate of tax for all individuals.

To see how this actually works in the real world we have some examples below.

For these tax calculations we are using the rates for the 2018/19 tax year which are as follows:

Personal allowance: £11,850

Basic Rates: £11,851 to £46,350

Higher Rate: £46,350 to £150,000

Example 1: Basic rate taxpayer

For consistency we will use the same figures which we mentioned earlier. These were rental income £50,000, mortgage interest £15,000 and other expenses £5,000. There is no other income.

 Old Rules (Pre April 2017)New Rules (Post April 2020)
Rental Income£50,000£50,000
Mortgage Interest(£15,000)(£Nil) – restricted to Nil
Other Expenses(£5,000)(£5,000)
Rental Profits£30,000£45,000
   
Tax Liability Calculation:  
Personal Allowance£11,850 x 0% = £Nil£11,850 x 0% = £Nil
Basic Rate£18,150 x 20% = £3,630£33,150 x 20% = £6,630
Tax Due£3,630£6,630
Less 20% reduction on interestN/A£15,000 x 20% = (3,000)
Final Tax Liability£3,630£3,630

Example 2: Higher rate taxpayer

To keep the examples consistent we will use the exact same figures as above regarding the rental income and costs but we will include self employment income of £35,000.

 Old Rules (Pre April 2017)New Rules (Post April 2020)
Self-Employed Income£35,000£35,000
Rental Income£50,000£50,000
Mortgage Interest(£15,000)(£Nil) – restricted to Nil
Other Expenses(£5,000)(£5,000)
Total Income£65,000£80,000
   
Tax Liability Calculation:  
Personal Allowance£11,850 x 0% = £Nil£11,850 x 0% = £Nil
Basic Rate£34,500 x 20% = £6,900£34,500 x 20% = £6,900
Higher Rate£18,650 x 40% = £7,460£33,650 x 40% = £13,460
Tax Due£14,360£20,360
Less 20% reduction on interestN/A£15,000 x 20% = (3,000)
Final Tax Liability£14,360£17,360

So, what do these figures tell us? They show that basic rate taxpayers are unaffected by the changes. (Example 1 resulted in both scenarios having the same tax liability of £3,630).

By April 2020 the basic rate tax is forecast to increase to £50,000. Therefore if your total income (employment income, self-employed income and rental profits) is below £50,000 then you will be unaffected.

However higher rate taxpayers will be affected. Their extra tax liability can then be calculated by taking the mortgage interest and multiplying by 20%. The 20% being the difference between the higher rate tax of 40% and the basic rate tax of 20%. In our example above the mortgage interest was £15,000 thus giving an additional tax liability of £3,000.

What happens to mortgage tax relief between 2017 and 2020?

The mortgage tax relief changes are being implemented gradually over the years 2017 to 2020.

 Deduct from Rental IncomeDeduct at Basic Rate
Tax Year 2016/17100%0%
Tax Year 2017/1875%25%
Tax Year 2018/1950%50%
Tax Year 2019/2025%75%
Tax Year 2020/210%100%

Example 3: Higher rate tax payer in the tax year 2017/18

Using the exact same figures as in example 2, we get the following results for the 1st year of implementation.

 New Rules 2017/18
Self-Employed Income£35,000
Rental Income£50,000
Mortgage Interest (75%)(£15,000) x 75% = (£11,250)
Other Expenses(£5,000)
Total Income£68,750
  
Tax Liability Calculation: 
Personal Allowance£11,850 x 0% = £Nil
Basic Rate£34,500 x 20% = £6,900
Higher Rate£22,400 x 40% = £8,960
Tax Due£15,860
Less 20% basic rate (25%)(15,000) x 25% x 20% = (£750)
Final Tax Liability£15,110

As explained in the previous examples the mortgage tax relief is being reduced for higher rate taxpayers down to the basic tax rate. A higher rate tax payer will therefore pay an additional £3,000 tax if their mortgage interest was £15,000.

This is being implemented over 4 years. Therefore the final tax liability in year 1 (2017/18) of £15,110 isn’t surprising as it is £750 more tax than the 2016/17 figure of £14,360.

Year 2 (2018/19) will have additional tax of £1,500. Year 3 (2019/20) will have additional tax of £2,250 before finally the full tax increase of £3,000 is incurred in 2020/21.

Can anything be done to avoid the reduction in mortgage tax relief?

The restriction in mortgage tax relief only affects individuals. Limited companies are therefore unaffected by these changes.

Therefore one possibility to avoid the reduction in mortgage tax relief would be to transfer a property or properties into a Limited company. This would then trigger capital gains tax charges and stamp duty liabilities. There is also potential unforeseen tax consequences in having profits in a Limited company therefore tax planning must be done prior to any transfers.

Conclusion

The new restrictions in mortgage tax relief could pose a significant risk to those property portfolios with high levels of interest payments.

It is therefore important to act now and see how this risk can be reduced before the full effects come into law in April 2020.

Landlords with several properties will need to undertake a full review of their property portfolio to see the effects of the new tax rules.

Properties with high mortgage interest payments may no longer be profitable with the added tax liabilities, therefore landlords should consider transferring them into a Limited company or putting them up for sale.

Should landlords then choose to sell off some of their portfolio it could prove to be an opportunity for cash rich individuals to snap up a bargain if the market is flooded with buy to let properties.

If you are a higher rate taxpayer and have rental properties with mortgages you will be affected. Please contact us and we will then calculate your additional tax liabilities and assist with tax planning on how this tax can be minimised.

DISCLAIMER – Please note that the content contained in this article is for general information only and is not a substitute for professional advice – read our full disclaimer

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