Property tax questions answered in plain English
Despite their introduction in April 2017, the changes to mortgage interest tax relief are still a hot topic of conversation among property investors. This may be because of the long, drawn-out process of their full effect. It could be because the accountants of many property investors find it hard to explain what’s happening in plain English. Whatever the reason, one of the most common questions we’re asked is, “How will the change to mortgage interest tax relief affect me?”
Now, if and how the changes affect you depends upon your personal situation, but there are some general rules that will apply to you. These should help you determine how much extra tax you may have to pay (if any). You’ll also learn the first steps to take to reduce the extra tax you may be asked to pay.
Will the change affect you?
There are four types of property investor who will be affected by the changes to mortgage interest tax relief:
- A UK resident who lets property (either in the UK or overseas)
- A non-UK resident who lets property in the UK
- A person who lets residential investment property as a partner of others
- A trustee of a trust holding UK residential property directly
Of course, if you own the property outright (without a mortgage on it), the new rules won’t affect you either.
What is happening to mortgage interest tax relief?
As a property investor with a mortgage, you used to be able to fully offset the mortgage payments against your rental income. For example, if you earned £10,000 in rental income and paid £8,000 in mortgage interest, you would only pay income tax on £2,000*. This could reduce your tax bill by thousands, especially if you are a higher rate taxpayer.
From 2017 through to 2020/21, this is being phased out. By 2020/21, you will only be able to claim tax relief at the basic rate of income tax on your mortgage interest payments. If you are a higher rate taxpayer and don’t plan to mitigate this, you will pay more income tax on your rental income.
(*Mortgage interest payments are not your only expense when investing in property. There is a range of costs you can deduct to reduce your tax liability on buy-to-let rental income.)
How are the changes being phased in?
The tax year 2016/17 was the last year in which you could fully offset your mortgage interest payments against rental income to reduce your income tax liability. From the last tax year (which ended on 5th April 2018), the mortgage interest payments you can offset against your rental income is as follows:
- Tax year 2017 to 2018 – 75%
- Tax year 2018 to 2019 – 50%
- Tax year 2019 to 2020 – 25%
- Tax year 2020 to 2021 – 0%
On the balance of the mortgage interest payments (the portion you cannot offset), you may only claim tax relief at the basic rate of income tax (currently 20%).
How does this affect higher rate taxpayers?
If you are a basic rate taxpayer, you won’t receive a higher tax bill. But if you pay tax at the higher rate or additional rate, your tax bill will increase. You should be aware that if the rental income pushes you into a higher tax bracket, you will be liable to pay more tax. Here’s an example of how much extra income tax you might pay because of these changes:
You receive rental income of £11,400 per year and pay mortgage interest payments of £7,200.
|Tax year||Proportion of mortgage interest deductible (Proportion now qualifying for tax relief at 20%)||Taxable income||Tax liability||Tax relief on mortgage payments||Post-tax and mortgage income|
In a nutshell, as a higher rate taxpayer with a buy-to-let mortgage, you will pay increasingly more tax because of the changes to mortgage interest tax relief.
Can you mitigate the effects of these changes?
For most people, the answer will be yes, there are ways to invest in property and reduce tax. These include transferring ownership to a lower rate taxpaying spouse. A very popular strategy is to invest in property as a limited company instead of in your personal name.
If you are a higher rate taxpayer and are considering investing in property or adding to an existing portfolio, you should take specific advice about your tax situation.