The system for claiming tax relief on mortgage interest for UK residential landlords underwent a fundamental change, fully implemented in April 2020. The old system, which allowed landlords to deduct their finance costs from their rental income before calculating their tax bill, was replaced. The current system provides a 20% tax credit against your final tax liability.
This change significantly altered the tax calculation for individual landlords, particularly those who are higher or additional-rate taxpayers.
The Old System vs. The New System
Before the Change (Pre-2017):
Landlords could deduct all their mortgage interest and other finance costs from their rental income. This reduced their “profit” and therefore the amount of income tax they paid. This was especially beneficial for higher-rate taxpayers, as it reduced income that would have been taxed at 40% or 45%.
Example (Old System):
- Gross Rental Income: £20,000
- Allowable Expenses (excluding finance): £4,000
- Mortgage Interest: £10,000
- Taxable Profit: £20,000 – £4,000 – £10,000 = £6,000
- A higher-rate (40%) taxpayer’s tax bill: £6,000 x 0.40 = £2,400
The Current System (Post-2020):
Now, landlords must declare their full rental income, minus only their allowable expenses (not including finance costs). They then receive a tax credit equivalent to 20% of their mortgage interest costs. This credit is deducted directly from their final tax liability.
Example (New System):
- Gross Rental Income: £20,000
- Allowable Expenses (excluding finance): £4,000
- Property Profit (for tax purposes): £20,000 – £4,000 = £16,000
- This £16,000 is added to your other income (e.g., salary) to determine your tax band.
- Tax Calculation:
- Initial Tax Liability (at 40%): £16,000 x 0.40 = £6,400
- Tax Credit: £10,000 (mortgage interest) x 0.20 = £2,000
- Final Tax Bill: £6,400 – £2,000 = £4,400
As you can see, the higher-rate taxpayer’s tax bill increased from £2,400 under the old system to £4,400 under the new system.
The Impact of the 20% Tax Credit
- Basic-Rate Taxpayers: If your total income (including the rental profit) remains within the basic-rate band, the 20% credit often leaves you in a similar position to the old system.
- Higher and Additional-Rate Taxpayers: You are disproportionately affected. You are effectively losing the higher-rate relief you previously received, as the credit is only given at the 20% basic rate. This can push some landlords into a lower tax band or significantly increase their tax bill, as shown in the example.
The “0%” Concept
The scenario of “0 tax relief” is not accurate. The relief is a 20% tax credit. It is not 0%. However, for a higher-rate taxpayer who previously received 40% relief, the effective value of the relief has been cut in half.
Key Takeaway
You can no longer deduct mortgage interest from your rental income to reduce your profit. Instead, you calculate tax on a higher profit figure and then receive a tax reduction equal to 20% of your mortgage interest costs. This has made property investment less tax-efficient for individual landlords who are higher-rate taxpayers, leading many to consider operating through a limited company, where different tax rules apply.
