Claiming of tax relief on Mortgage Interest over the next few years

If you're a little confused over changes in tax law, this article will explain what this means for landlords and what to expect in practical terms. 

Who is likely to be affected

If you're an Individual that receive rental income on residential property in the UK or elsewhere and incur finance costs (such as mortgage interest), excluding where the property meets all the criteria to be furnished holiday letting, then this legislation will affect you. Essentially 100% of our clients who are landlords! 

General description of the measure

This measure will restrict relief for finance costs on residential properties to the basic rate of Income Tax. This will be introduced gradually from 6 April 2017. Finance costs include:

  • mortgage interest
  • interest on loans to buy furnishings
  • fees incurred when taking out or repaying mortgages or loans.

No relief is available for capital repayments of a mortgage or loan.

Landlords will no longer be able to deduct all of their finance costs from their property income to arrive at their property profits. They will instead receive a basic rate reduction from their income tax liability for their finance costs. Landlords will be able to obtain relief as follows:

  • in 2017 to 2018 the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate reduction.
  • in 2018 to 2019, 50% finance costs deduction and 50% given as a basic rate tax reduction
  • in 2019 to 2020, 25% finance costs deduction and 75% given as a basic rate tax reduction
  • from 2020 to 2021 all financing costs incurred by a landlord will be given as a basic rate tax reduction.

Making sense of these new rules

The change to mortgage interest relief in the 2015 emergency Budget was not only a bit of a shocker but also tricky to understand. Most media commentators and indeed many accountants weren't entirely sure what it meant either. With no particularly clear or simple example online anywhere else, I thought I'd post a few examples here. We've got sometimes to discuss the rights and wrong and what to do about it, but for now, here's the breakdown.

The current rules

At the moment, (until April 2016), you can deduct your mortgage interest (plus associated costs like arrangements fees) along with all your other costs before determining your taxable profit.

So, to take a simple example:

£10,000 rental income

£5,000 mortgage interest costs

£1,000 other costs

= £4,000 profit

You are then taxed on that profit at your marginal rate - so basic rate (currently 20%) taxpayer would pay a tax of £800, and a higher rate (currently 40%) tax paper would pay £1,600.

(There's also an 'additional rate' of 45% for income about £15,000 which I'm ignoring here for simplicity)

The new rules

By the time the new measures have fully taken effect in April 2020, you will no longer be able to deduct mortgage interest costs from your taxable profits. Instead, everyone will be able to claim a basic rate allowance for their finance costs, irrespective of their marginal rate. This is being phased in over four years.

So, using the same example as able with the new rules, the figures would be:

£10,000 rental income

£5,000 mortgage interest costs (not deducted)

£1,000 other costs

= £9,000 profit

Yikes! A basic rate taxpayer would pay £1,800 tax on that new £9,000 profit, and a higher rate taxpayer would pay £3,600.

BUT WAIT - everyone gets to claim a basic rate deduction of 20% of that £5,000 mortgage interest cost. That's £1,000. So the final portion is:

Higher rate tax payer:

40% tax on £9,000 profit = £3,600

Minus £1,000 deduction (20% of £5,000 interest cost)

= £2,600 tax to pay

Basic Rate tax paper:

20% tax on £9,000 profit = £1,800

Minus £1,000 deduction (20% of £5,000 interest cost)

= £800 tax to pay

So what's happened?

First, you'll notice that the basic rate taxpayer ends up paying exactly the same amount of ta under the new system £800. The higher rate taxpayer however, ends up paying £1,000 more. 

But this doesn't mean that the basis rate taxpayer is unaffected. Because the deduction is applied after calculating the taxable profit, everyones' 'profit' has actually increased - from £4,000 to £9,000.

This means that people whose income (from property plus employment and other sources) is currently below the higher rate threshold may end up getting pulled into the higher rate band as a result of their higher property 'profits' 

The silver lining, such that it is, is that the higher rate threshold will have risen from its current £42,385 to £50,000 by the time this measure takes full effect in 2020. 

About the Author

Phillip Bowick, from The Provincial Tax Shop, runs an accounting practice with over 30 years experience. They can prepare accounts from your own records whether these be manual or computerised.

They offer:

  • A free no-obligation discussion about your business requirements
  • Fixed accounting fees agreed in advance and not dependent on income level
  • VAT registrations and advice
  • Tax planning
  • Company forecasts

If you would like any specific help and tax advice, please call (01942) 233737 or write to