Looking for mortgage interest tax relief and how it affects you? This article explains the current rules, eligibility and how to claim. We’ll also look at the changes over the years and what it means for basic and higher rate taxpayers. Understanding one’s outstanding mortgage balance is crucial for calculating mortgage interest tax relief.

Summary

• Mortgage interest tax relief went from full deductions to a fixed 20% tax credit for landlords by 2021 and it’s a game changer for financial planning.
• Higher rate taxpayers are now paying more tax as they can no longer deduct mortgage interest at their tax rate, so they’re looking for other tax reduction strategies.
• Landlords can incorporate their property business and get full mortgage interest deductions as business expenses despite the extra complexity.
• Only interest paid on a qualifying loan is eligible for mortgage interest tax relief.

What is Mortgage Interest Tax Relief?

Mortgage interest tax relief is a valuable tax deduction available to homeowners and landlords who pay interest on their mortgage. This relief allows individuals to reduce their taxable income by the amount of mortgage interest paid, thereby lowering their overall tax liability. In the UK, this relief is restricted to the basic rate of income tax, which is currently set at 20%. This means that homeowners and landlords can only claim tax relief on their mortgage interest payments at this basic rate, rather than at higher or additional rates of tax. By understanding and utilizing mortgage interest tax relief, individuals can effectively manage their tax obligations and potentially save a significant amount on their tax bills.

Changes to Mortgage Interest Tax Relief Over Time

Over the years the mortgage interest tax relief has undergone a big change. Initially landlords could deduct 100% of their mortgage interest from rental income and reduce their taxable income. But that changed in April 2017 when the government introduced a phased reduction in tax relief for finance costs. In April 2020 they removed the ability to deduct mortgage interest from rental income altogether, it’s a complete change in the tax landscape.

During the transition period from 2017 to 2020 landlords could deduct a decreasing percentage of their finance costs each year and by January 2021 it was fully restricted. This was meant to be a gradual change but it’s had a big impact on financial planning and taxable income. The phased reduction specifically impacted landlords managing residential properties, limiting their ability to deduct mortgage interest. The new system is a 20% basic rate tax credit on mortgage interest paid, compared to the full deduction before.

These changes have had big implications for landlords, especially those with big mortgage interest expenses. Understanding this history helps you understand the current tax relief system and what it means for your financial strategy.

How Mortgage Interest Tax Relief Works Now

The full system is now in place by 2021 and landlords can claim a tax credit based on 20% of the mortgage interest paid. Instead of deducting the full interest amount, landlords with residential property get a tax credit at the basic rate which reduces their tax liability.

The system is designed to reduce income tax owed not create tax refunds so landlords can’t offset other taxes with their mortgage interest payments. For basic rate taxpayers this might not make much difference but for higher rate taxpayers it’s a big difference.

The tax credit is 20% of the lower amount between the finance costs and property business profits. This simple calculation ensures the tax relief is aligned with the actual cost of mortgage interest and is a fair approach to tax relief and finance cost.

Who is Eligible for Mortgage Interest Tax Relief

To qualify for mortgage interest tax relief taxpayers must meet certain ownership and usage conditions. Mainly the property must be owned by the taxpayer claiming the relief. This excludes individuals who don’t have direct ownership of the property, so the tax credit is only available to those who are paying the mortgage repayments.

And the type of loan also plays a part. Buy to let mortgages have different rules. If a taxpayer’s total income including mortgage interest is above certain thresholds the amount of mortgage interest that qualifies for the tax credit may be limited so you need to plan carefully.

How to Calculate Your Mortgage Interest Tax Credit

Calculating your mortgage interest tax credit is a simple but precise process. The tax credit is 20% of the mortgage interest paid so you have a clear figure to work with. For example if your mortgage interest for the year is £10,000 your tax credit would be £2,000. The outstanding mortgage balance from previous years can impact this calculation, as it relates to the increased interest paid in different years.

If you didn’t pay mortgage interest for a full year the credit and cap are applied pro-rata to the amount paid. This ensures the tax relief is aligned with your actual cost. Any unused finance costs that can’t be used in one year can be carried forward to the next year so there’s some flexibility in managing your tax liability.

Getting your mortgage interest tax credit right is key to financial planning, so you can work out your overall tax liability and make informed decisions on property and mortgage payments.

Mortgage Interest Tax Relief and Income Tax

Mortgage interest tax relief is intrinsically linked to income tax, as the relief is calculated based on the amount of mortgage interest paid. The resulting tax reduction is then applied to the individual’s income tax liability. In the UK, the tax relief is capped at the basic rate of income tax, which means that higher rate taxpayers may not be able to claim the full amount of mortgage interest paid as a tax deduction. Despite this limitation, mortgage interest tax relief can still offer substantial savings, especially for homeowners and landlords with large outstanding mortgage balances. By reducing the taxable income, this relief helps in lowering the overall tax liability, making it a crucial component of financial planning for those with significant mortgage interest payments.

Higher Rate Taxpayers

Higher rate taxpayers have been hit hard by the changes to mortgage interest tax relief. Since April 2017 they can no longer deduct interest costs from their taxable income at the higher rate so their tax liability has gone up. By 2020 the relief was limited to the basic rate of 20% so it’s gone up again.

This has resulted in a big increase in tax bills for higher rate taxpayers as the difference between the higher rate and the basic rate is big. For example a higher rate taxpayer with big mortgage interest payments now gets a tax credit at 20% instead of the higher rate. Higher rate taxpayers with residential property face increased tax liabilities due to these changes, significantly impacting their rental income. This has forced many to look for ways to reduce their increased tax liability such as making pension contributions or Gift Aid donations to reduce their taxable income.

It’s particularly harsh for those whose rental profits have gone up and mortgage interest has gone down so they’re getting pushed into higher tax brackets without realising. Higher rate taxpayers need to understand this to manage their finances and find ways to reduce tax.

Company for Mortgage Interest Relief

For landlords looking to get their tax right, incorporating their property business can be more tax efficient. Unlike individual landlords, companies are not subject to the same mortgage interest relief limits so they can deduct mortgage interest as a business expense. This can mean big tax savings and a more efficient structure. Incorporating a property business can be particularly beneficial for landlords managing multiple residential properties, as it allows them to navigate the updated tax landscape more effectively.

But incorporating a rental property business comes with extra costs and complexity. Landlords need to consider corporation tax, administrative burdens and potential legal implications. Tax professionals can be very helpful in navigating these complexities so the transition is smooth and tax efficient.

Despite the challenges, the benefits of incorporation make it an attractive option for many landlords. Weigh up the pros and cons and decide if incorporating your property business is for you.

Mortgage Interest Tax Relief on Your Tax Return

Mortgage interest tax relief requires attention to detail during the tax return process. You need to file an income tax return to claim the relief and make sure all the relevant info is reported. Correctly reporting a qualifying loan is crucial to claim mortgage interest tax relief. The mortgage interest tax credit option is on the tax credits page during the income tax return process.

Submitting the required documentation online via MyAccount or ROS makes it easier and faster for you. This online submission reduces the risk of errors and delays.

Follow these steps and you can claim your mortgage interest tax relief and get the benefits and be tax compliant.

What if You Don’t Qualify for Mortgage Interest Tax Relief?

If you don’t qualify for mortgage interest tax relief don’t worry. There’s the Homeowner’s Once-Off Payment to help. The application period for this payment is 1 September 2024 to 31 March 2025 so there’s a window to apply if you’re eligible. An individual’s outstanding mortgage balance might affect their eligibility for the Homeowner’s Once-Off Payment.

If your costs exceed the allowance for a year you can carry the excess forward to future years so you don’t lose the tax benefits. Getting help with the application process will ensure you get the most out of the alternatives.

Mortgage Interest Tax Relief Examples

To show how mortgage interest tax relief works in practice let’s look at three scenarios: a basic rate taxpayer, a higher rate taxpayer and multiple owners of a property.

These examples will show how the relief works in different situations, particularly focusing on the impact of mortgage interest tax relief changes on landlords with residential property.

Example 1: Basic Rate Taxpayer

Brian is a basic rate taxpayer with a total income of £36,000 for the tax year 2020 to 2021. Brian’s mortgage interest for the year was £15,000 on a qualifying loan. Under the current system Brian’s mortgage interest tax credit was 20% of the interest paid so £600.

As a basic rate taxpayer Brian gets a fixed percentage credit on his mortgage interest which reduces his overall tax bill. This example shows how simple the tax relief is for basic rate taxpayers.

Example 2: Higher Rate Taxpayer

Now let’s look at John, a higher rate taxpayer with £18,000 rental income and £35,000 self-employment income per year. John’s mortgage interest for the year is £8,000. John is a higher rate taxpayer so his mortgage interest relief is limited to 20% of the interest paid.

John’s outstanding mortgage balance from previous years also affects his current tax credit calculation, as the increased interest he paid impacts the relief he can claim. In this scenario John’s tax credit would be £1,600 which is much lower than he would have got under the old system. This example shows the financial impact on higher rate taxpayers who are now paying more tax due to the changes in mortgage interest relief.

Example 3: Multiple Owners

Finally let’s look at Jennifer who owns a rental property with another person. Jennifer’s mortgage interest is £8,000 and her total income from employment and the rental property is £36,000. In multiple ownership scenarios the mortgage interest tax credit must be split based on each person’s share of the interest paid.

There is only one mortgage interest tax credit per property so co-owners will need to agree how the credit is split. For their residential properties, Jennifer and her co-owner manage the tax credit by dividing it according to their respective shares. This example shows how important it is to communicate with co-owners to ensure the tax benefits are shared fairly.

Conclusion

Mortgage interest tax relief is key to financial planning for landlords and homeowners. The change from full deduction to basic rate tax credit has big implications for higher rate taxpayers. Calculate your tax credit correctly and consider incorporation and you can maximise your tax position.

In summary, get informed and proactive about your mortgage interest tax relief and you’ll save tax and get better outcomes. Understanding these changes is especially crucial for landlords managing residential properties. Take control of your finances.

Frequently Asked Questions

Who is eligible for mortgage interest tax relief?

Property owners who satisfy specific ownership and usage conditions, including those with buy-to-let mortgages, are eligible for mortgage interest tax relief.

How is the mortgage interest tax credit calculated?

The mortgage interest tax credit is calculated at a fixed rate of 20% of the mortgage interest incurred, allowing any unused finance costs to be carried forward to the next tax year. This approach ensures taxpayers can benefit from their mortgage interest even if not fully utilized in the current year.

How do higher rate taxpayers benefit from mortgage interest tax relief?

Higher rate taxpayers benefit from mortgage interest tax relief by receiving a 20% tax credit on their mortgage interest payments, which can help reduce their overall tax liability. This credit can effectively lower the financial burden of their mortgage costs.

What options are available if I don’t qualify for mortgage interest tax relief?

If you do not qualify for mortgage interest tax relief, you can consider options such as the Homeowner’s Once-Off Payment and carrying forward excess finance costs to future tax years. These alternatives can help alleviate some financial burdens.

How can I claim mortgage interest tax relief on my tax return?

To claim mortgage interest tax relief on your tax return, you need to file an income tax return and submit the required documentation online through Revenue’s MyAccount or ROS.