From the 2020/21 tax year onwards, no deduction has been allowed for mortgage interest in calculating rental profits. Instead, 20% of the mortgage interest paid on a rental property is applied as a reduction to the tax bill
The income tax reduction is only allowed against tax on rental profits. If there is a rental loss arising in the tax year, or if the rental profit is covered by the personal allowance, then the mortgage interest tax reduction will be carried forward to future years until such time as there are taxable rental profits.
The example below shows how the mortgage interest reducer is applied.
2022/23 Tax Year
Mr Baggins receives a salary of £55,000 and gross rental income of £15,000. He pays mortgage interest of £6,000 and has other rental expenses of £2,000.
No mortgage interest is deducted from the rental income, only the other rental expenses of £2,000, giving a rental profit of £13,000 which is taxable at the higher rate of 40% because his salary uses the whole of the basic rate band and personal allowance totalling £50,270.
The income tax liability on the rental profit is £5,200 (£13,000 at 40%).
The whole of the mortgage interest (£6,000) is calculated as a tax reducer at the basic rate of 20%. This tax reducer of £1,200 is deducted from the income tax liability of £5,200 giving Mr Baggins a net income tax liability on his rental profits for the 2022/23 tax year of £4,000 (£5,200 – £1,200).
The changes to the mortgage interest relief have led to higher tax liabilities for some landlords and will potentially have an impact on other areas, for example, the loss of the personal allowance where income exceeds £100,000 or the High-Income Child Benefit Tax Charge which applies where income exceeds £50,000.
Here at Plus Accounting we will be very happy to help you with your rental property queries with our personal tax advisory and compliance services.
Author: Plus Accounting
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Date Published: 10 September 2020
Last Updated: 07 March 2023