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Everything you need to know about buy-to-let tax changes

With tax relief on mortgage interest being phased out gradually since April 2017, landlords have had to change the way they declare their income, resulting in most seeing a significant rise in their tax bills. By April 2020, landlords will no longer be able to deduct any of their mortgage expenses from their rental income to reduce their tax bill. This guide explains what changes are happening with buy-to-let tax and how these will affect landlords.

What is buy-to-let?

Buy-to-let is the process of buying a property in order to rent it out to tenants. In this instance, the property is usually considered a medium to long-term investment.

Previous buy-to-let mortgage interest tax relief

If you were a landlord with a mortgage on your rental property before April 2017, any interest you paid towards your mortgage payments could be deducted from the income you made from your rental property, before you paid tax on it. 

For example:

If your annual income from your rental property was £10,000 and the interest on your mortgage payments totalled £8,000, you could deduct the £8,000 from your rental income before you paid tax. This meant you only had to pay tax on the remaining £2,000. If you were in the 20% tax bracket, this would give you a total tax bill on your rental income of £400.

New buy-to-let tax rules

To meet new buy-to-let tax rules, a new tax system began being phased in at the beginning of the 2017-2018 tax year. This meant that changes would be gradual, year-by-year, until they become fully in force by 2020 – rather than a significant, immediate change.

During each financial year in the transition period, the percentage of mortgage interest payments that you can deduct from your rental income will decrease by 25%, while the percentage of those interest payments that qualify for the new tax credit will increase by 25%.

Tax Year % mortgage interest payment deductible from rental income % mortgage interest payments qualifying for the new 20% tax credit
Before April 2017 10% 0%
2017 – 2018 75% 25%
2018 – 2019 50% 50%
2019 – 2020 25% 75%
After April 2020 0% 100%

 

By 2020, landlords will not be able to deduct any of their mortgage interest payments from their rental income before paying tax. However, by this date a landlord’s entire interest payment will qualify for a 20% Mortgage Interest Relief instead.

For example:

If a landlord was receiving £10,000 a year from rent and paying £8,000 in mortgage interest payments, they will still be taxed on the full £10,000 (dependant on tax bracket). A total of £1,600 can however then be taken away from their tax bill due to the 20% Mortgage Interest Relief.

Detailed buy-to-let tax relief example

This table explains in more depth how the new tax system will affect how much tax a landlord has to pay when the new rules are fully in use in 2020, compared to the 2016-2017 tax year.

 

2016 – 2017 2020 – 2021
Rental Income £10,000 Rental Income £10,000
Mortgage Interest Payments (to be deducted) £8,000 Taxable Income £10,000
Taxable Income £2,000 Tax Due @ 25% £2,500
Tax Due (25%) £500 Mortgage Interest Relief (20%) £500
Buy to Let Profit £1,500 Tax Due £2,000
Buy to Let Profit (after tax and mortgage payments of £8,000 are taken from income) £0

Key landlord tax changes

As well as paying more tax on rental income, the main buy-to-let tax changes for landlords are:

  • Higher tax brackets
    With all rental income now having to be declared, landlords may find themselves moving up into a higher tax bracket.
  • Negative earnings
    Landlords with small profit margins might end up in the ‘red’ after tax, resulting in them losing money.

Please note: No information provided here should be taken as tax advice. For tax advice you should always consult with an independent tax adviser.