The mortgage interest restriction is a legislative measure affecting landlords' ability to claim tax relief on finance costs associated with residential rental properties.
Introduction to Mortgage Interest Restriction
Introduced in the Summer Budget 2015 and phased in from April 6, 2017, this rule limits tax relief on finance costs, such as mortgage interest, to the basic Income Tax rate of 20%. The affected costs include:
- Mortgage interest payments
- Loan interest for buying furnishings
- Loan and mortgage arrangement fees
This shift marked the end of full tax relief for capital repayments on mortgages or loans for residential property landlords.
Purpose Behind the Change
Previously, landlords could deduct all their mortgage interest from rental income before calculating tax due, significantly reducing tax bills, especially for higher-rate taxpayers. The implementation aimed to level the playing field, ensuring that the tax advantage does not disproportionately benefit higher-income landlords. By transitioning to a 20% tax credit system fully in place from April 6, 2020, all landlords now receive the same rate of tax relief on mortgage interest costs.
Impact on Landlords
The restriction primarily impacts landlords who are higher or Additional Rate Taxpayers by reducing the amount of mortgage interest cost they can offset against rental income for tax purposes. The move to a flat 20% tax credit means that landlords will no longer be able to claim tax relief at their marginal tax rate, which could be as high as 40% or 45%.
Landlords operating within lower tax brackets may see little to no change, as they already received tax relief at the basic rate. However, for those with substantial rental operations, structuring their business as a limited company could offer more favorable conditions for claiming finance costs, as companies are exempt from these restrictions and can still deduct the entire amount of mortgage interest from rental income.
Conclusion
The mortgage interest restriction represents a significant shift in how landlords manage their tax liabilities. Understanding its implications is crucial for effective financial planning and tax compliance.
