It is difficult to comprehend why the UK government has decided to reduce and eventually eliminate mortgage interest tax relief on buy to let investments. Let’s not forget that the UK property market is still well short of providing the necessary newbuilds, the introduction of new social housing can be extremely slow to come online and government/local authority budgets are still under enormous pressure. So, what is the real cost of eliminating buy to let mortgage interest tax relief and is there any way to reduce this?
Old-style tax relief
Prior to April 2017 the old-style tax relief on mortgage interest was fairly straightforward. A buy to let property which created rental income of £10,000 per year bought with a mortgage with interest charges of £9000 per year meant a net £1000 income. For those in the 20% tax bracket this equated to a £200 tax charge although for those in the higher tax brackets the charge would obviously be higher. However, this is all changing.
New tax relief rules
The changes began in the tax year 2017/18 where only 75% of the mortgage interest payments could be deducted from rental income. The 25% of interest rate payments taken out of the tax equation would qualify for the government’s new 20% tax credit. In the tax year 2018/19 the percentage of mortgage interest deductible against rental income fell to 50% and the percentage qualifying for the 20% tax credit increased to 50%. In 2019/20 only 25% of mortgage interest payments will be deductible while 75% of mortgage interest payments will qualify for the 20% tax credit. After April 2020 a buy to let investor will not be able to deduct any mortgage interest payments against rental income but 100% of mortgage interest payments will qualify for the 20% tax credit.
Who will this hit hardest?
There is no doubt that the changes to the percentage of mortgage interest deductible against rental income will hit those in the highest tax brackets hardest. For example, where a buy to let investor receives £10,000 rental income per annum, those in the 20% tax bracket would have an initial tax bill of £2000. However, if you take the same scenario with £9000 mortgage interest per annum this will qualify for the 20% tax relief (£1800) reducing the initial tax bill from £2000 down to £200. So, there is no change for basic rate taxpayers.
If we look at those in the 40% tax bracket the situation is very different. Using the same figures, their initial tax bill would be £4000 on the £10,000 rental income. However, the new mortgage interest relief can only be applied at 20% which means a deduction of £1800. Their total tax bill would be £2200 compared to just £400 under the old system. The situation for a 45% taxpayer is even bleaker with an initial tax charge of £4500 less the £1800 deduction leading to a tax bill of £2700 from 2020 onwards. This compares to a tax bill of just £450 under the old system.
The removal of mortgage interest rate tax relief against rental income only relates to personal investments therefore many people are now looking to acquire their properties and build their property portfolios within limited companies. In this scenario, finance costs can still be offset against income in a similar fashion to the pre-2017 personal tax system for buy to let investors. There are additional costs to consider when setting up a company and it is advisable to discuss your ideas and your personal tax situation with your financial adviser/accountant.