We are not expecting it to come as breaking news to most people that the UK government have introduced a change to the mortgage interest deduction for individual landlords, a change which took effect this year on 6 April. If you haven’t heard about the change, and you are a higher (40%) or additional rate (45%) taxpayer with mortgaged rental properties, then we’re sorry to be the bearer of bad news.
Given we’re half way through the first year of the changes, now seems like a good time to highlight some of the lesser known complexities:
- “Below the line” tax relief
Under the old rules, any mortgage interest due on a rented property was an allowable deduction against your rental income in reaching the “taxable profits” from that property (read our Property Tax Guide for more details on the UK tax treatment of rental income).
The new rules, however, allow for 20% of the mortgage interest suffered to be deducted directly from your tax bill. This is sometimes referred to as “below the line” tax relief. As seasoned tax professionals we see this all the time with say foreign tax credits, or the Research & Development regime, but it is definitely new for the average individual landlord.
So whilst you could previously calculate your taxable profits and the consequent tax bill on your property income without considering the rest of your other income (such as employment, or investment income), this will no longer be possible. You’ll need to work out your rental profits, then work out the rest of your taxable income, then work out your tax liability and then go back to your rental income mortgage interest to work out the final tax payable. With us so far?
- The phase in
HM Government realised this change was going to make quite a big difference to the tax bill of some individual landlords, so it was decided to phase it in over a few years rather than make the change all at once. So, over the next 4 tax years, when preparing their tax returns landlords need to bear in mind the following:
- 2017/18: 75% of your mortgage interest is treated under the old rules as an allowable expense against your rental income and 25% is entitled to below the line tax relief at 20%.
- 2018/19: 50% of your mortgage interest is treated under the old rules as an allowable expense against your rental income and 50% is entitled to below the line tax relief at 20%.
- 2019/20: 25% of your mortgage interest is treated under the old rules as an allowable expense against your rental income and 75% is entitled to below the line tax relief at 20%.
- 2020/21: 100% of your mortgage interest is entitled to below the line tax relief at 20%.
- The restriction
Under the old rules, you were entitled to deduct all the mortgage interest you paid as an allowable expense against your rental income without any restrictions. If the mortgage interest deduction led to a loss, you could carry that loss forward, same as with any other allowable expense.
The new rules restrict the relief available to 20% of the lower of:
- Finance costs not deducted in the tax year (i.e. you mortgage interest that is not still treated under the old rules for the next few years, or just your total mortgage interest from 2020/21 onwards).
- The profits of that rental property that tax year.
- Total UK taxable income that tax year.
In practice this means that mortgage interest cannot create or increase the taxable loss from a rental property or lead to an overall tax refund.
Luckily you can carry forward any unrelieved excess mortgage interest to future years. But even that means if your rental property is making a loss before you consider your mortgage interest, you have to track the rental losses and your mortgage interest to the next tax year.
Don’t suffer in silence. We can help. If you’d like assistance with preparing your tax returns we can offer cost effective, fixed fee monthly packages. Don’t miss out on relief that is rightly due, or make a costly mistake in your calculations.
And if the cost is a big hit, why not talk to us about your options? There are a range of methods available for re-structuring your affairs to minimise the cost of these changes.