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In his summer budget George Osborne announced that landlords will only be able to offset mortgage interest at the basic rate of tax (20%) from 2020.

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This will be introduced gradually from 6 April 2017. The restriction will not apply where the property meets all the criteria of a furnished holiday letting.

mortgage interest: Current situation

Landlords pay income tax on their rental profit by declaring the amount they earn on a self-assessment tax return. The landlord can deduct mortgage interest (plus associated costs like arrangement fees) along with all other costs before determining the taxable profit. Tax is then charged on the rental profit applying the normal income tax bandings – 20% for basic rate taxpayers, 40% for higher rate taxpayers and 45% for additional rate taxpayers.

mortgage interest: New rules

Landlords will no longer be able to deduct all of their finance costs from their property income to arrive at their rental profits. The relief in respect of finance costs will be restricted as follows:

2017/18 75% allowed 25% basic rate
2018/19 50% allowed 50% basic rate
2019/20 25% allowed 75% basic rate
2020/21 Nil 100% basic rate

Example

This example is for a rental income of £10,000:

  • allowable expenses not including finance cost £2,000
  • finance cost of £3,000.

The tax position for a basic rate taxpayer will be as follows:

Profit before finance cost Finance cost allowed Taxable profit Tax at basic rate Relief on finance cost Total tax due
Current 8,000 3,000 5,000 1,000 Nil 1,000
2017/18 8,000 2,250 5,750 1,150 (150) 1,000
2018/19 8,000 1,500 6,500 1,300 (300) 1,000
2019/20 8,000 750 7,250 1,450 (450) 1,000
2020/21 8,000 Nil 8,000 1,600 (600) 1,000

While the total amount of tax due has not changed, this does not mean that the landlord’s tax position is unaffected. As taxable profit has increased from £5,000 to £8,000, it is possible that a taxpayer who is currently at the limit of the basic rate band might find himself in a higher rate tax position when nothing else has actually changed.

The tax position for a higher rate taxpayer will be as follows:

Profit before finance cost Finance cost allowed Taxable profit Tax at basic rate Relief on finance cost Total tax due
Current 8,000 3,000 5,000 2,000 Nil 2,000
2017/18 8,000 2,250 5,750 2,300 (150) 2,150
2018/19 8,000 1,500 6,500 2,600 (300) 2,300
2019/20 8,000 750 7,250 2,900 (450) 2,450
2020/21 8,000 Nil 8,000 3,200 (600) 2,600

As expected, a higher rate taxpayer ends up paying more tax as relief for finance costs is restricted to the basic rate.

saving tax on your mortgage

It is possible to make tax savings by buying a property through your limited company, however, the function of the property needs to be determined first as the intended use may incur a higher tax bill.

To find out more about setting up a limited company or our accounting services for small businesses (from one to 100 employees) for a fixed monthly rate, contact us today