Buy-to-let mortgage interest tax relief explained

Changes to tax relief rules mean some landlords face higher bills. We explain what the changes mean for you.

What is buy-to-let mortgage interest tax relief?

The way landlords must declare their rental income has changed, resulting in many facing higher tax bills.

While borrowing money through a Buy to Let Mortgage was once a major tax advantage, it's no longer the case. This guide explains what changes have taken place and how they've affected how much tax landlords have to pay.

Landlord mortgage interest tax relief in 2022-23

Since April 2020, you've no longer been able to deduct any of your mortgage expenses from your rental income to reduce your tax bill.

Instead, you now receive a tax credit, based on 20% of your mortgage interest payments.

This is less generous than the old system for higher-rate taxpayers, who effectively received 40% tax relief on mortgage payments.

The new system has been phased in gradually since 2017.

Why the tax credit is bad news for landlords

The new system means higher or additional-rate taxpayers can no longer claim the tax back on their mortgage repayments, as the credit only refunds tax at the basic 20% rate, rather than the top rate of tax paid.

Less obviously, the new rules could force some landlords into a tax bracket, because they'll need to declare the income that was used to pay the mortgage on their tax return.

This could push your total income into the higher or additional-rate tax brackets, depending on your income from other sources, such as your salary or pension.

Mortgage interest tax relief in 2023: an example

Assuming a landlord takes in £950 per month rental income and makes mortgage interest payments of £600 per month.

• They'll pay tax on the full £11,400 rental income they earn
• They'll pay £7,200 in mortgage interest
• They'll get a tax credit of £1,440 (£7,200 x 20%)
• A basic-rate taxpayer will pay £840 - no increase compared to the old rules
• A higher-rate taxpayer will pay £3,120 - double the amount payable under the old system

Can landlords incorporate to keep their mortgage interest relief?

This change in tax relief only affects private landlords - people who own their properties as individuals (or couples), rather than through a business.

In theory, by setting up a business that owns their rental properties, landlords will be able to continue to declare rental income after deducting the mortgage.

However, if you're considering doing this is vital to research it thoroughly, as even with this tax saving you could end up far worse off.

There are a few reasons for this, but the main one is that mortgage rates for businesses are more expensive than for private landlords, which could cost more than you'd save in higher tax relief.

You'd also need to pay an extra round of stamp duty when you transfer ownership of the property to the business. You can use our Buy To Let Stamp Duty Calculator to work out your bill.

Finally, if you incorporate your taxes will become more complex. Instead of paying income tax on your rental income, you'll need to file taxes for your business and pay corporation tax on your profits.

To receive the rental income, you'll need to pay yourself a dividend. This will be taxed as income, but at a lower rate than if you'd received the income directly.

You can find out more in this guide Dividend Tax Explained

Source: Which? Jan 2023 updated