Claiming interest on buy-to-let mortgages as a contractor
Anyone who has rental property or works in tax will know about the relatively recent changes HMRC have made to how landlords are allowed to claim the interest on their mortgages. See below:
| % of Mortgage Interest can be deducted from profits | % available as a basic rate deduction | |
| Prior Years | 100% | 0% |
| 2017-18 | 75% | 25% |
| 2018-19 | 50% | 50% |
| 2019-20 | 25% | 75% |
| 2020-21 | 0% | 100% |
Over the past few years HMRC have been tinkering not only with what percentage of mortgage interest is allowable as a direct expense but also with how principle private residency and lettings relief are calculated. It would be hard to argue with landlords who expressed the opinion that they are being somewhat put upon at the moment.
One crumb of comfort I offer to clients who manage their affairs in such a way as to remain within the basic rate tax bracket is the following; ‘the amount of tax you would be due to pay doesn’t change as deducting mortgage interest from pre-tax profits and offering relief at the basic rate on post tax profits will give the same effect.’ It is only when a client is a higher rate tax payer that they will feel the pinch,… except, this isn’t exactly the whole picture.
For clients who have the ability to moderate their annual income, I am thinking about contractors in the main, the above crumb of comfort has to be caveated. With less mortgage interest allowable as a direct expense, more of the rental income is included as income in the tax calculation. Even if relief is given at 20% later in the calculation, the effect of this additional rental income is to reduce what other income can be taken within the basic rate tax band. To illustrate my point please see below.
| Example 1 | 100% deduction | Example 2 | 100% basic rate relief | |
| Rental Income | £15,000.00 | Rental Income | £15,000.00 | |
| Mortgage Interest | £10,000.00 | Mortgage Interest | £0.00 | |
| Taxable Rental | £5,000.00 | Taxable Rental | £15,000.00 | |
| Limit before Higher Rate tax | £50,000.00 | Limit before Higher Rate tax | £50,000.00 | |
| Less rental income | £5,000.00 | Less rental income | £15,000.00 | |
| Remaining before Higher Rate Tax | £45,000.00 | Remaining before Higher Rate Tax | £35,000.00 |
The above example is slightly artificial but does get the point across. There would be relief in the second example of £10,000 at 20%, but this does nothing to stop the basic rate tax band being diminished.
I would urge anyone in the above situation, specifically contractors who try to remain within the basic rate tax band, to review exactly what income is expected from rental property in the current tax year. The more rental income shown in the tax calculation will mean less dividends you can take before hitting the higher rate.
The issues do not stop there however. For those higher rate tax payers who have reluctantly accepted their fate there could be an additional sting, the additional income from rental can affect Child Benefit claims and Personal Allowance abatement to name a couple.
There are some solutions to the above issues depending on your aspirations as a property owner. One would be to incorporate a second business just for property; within a limited company structure, mortgage interest is still a 100% deduction. Within a limited company structure you can moderate what income you taken out of the company.
As with everything, there are plusses and minuses to the above approach and very much depends on what your long terms plans are. If you are unsure about how these recent changes will affect you and the best way to move forward, give us a call.
Note: All the information and advice in this blog post was correct at the time of writing.
