Article relevant to the tax year 2020/21
Your section 24 mortgage interest relief cap tax questions answered
In this article we are going to try and answer the following questions:
– What is mortgage interest relief?
– Can I claim tax relief on mortgage interest UK
– Does mortgage interest reduce taxable income?
– Does property tax reduce taxable income?
– Can I deduct 100 mortgage interest?
– What are the new tax rules when it comes to mortgage interest?
Whilst you are reading this article you may wish to read our page on the subject of “buy to let tax rules for UK landlords” where we discuss all the different types of tax that you need to be aware of. Read Here for more (opens in a new tab)
What is Section 24 mortgage interest relief? The new tax rules
HMRC in all its wisdom will say that the mortgage interest that you pay on your property portfolio will be treated as zero cost. Therefore, the higher geared your property portfolio, the greater income you will be deemed to have received.
Pre 2017/18 property investors were allowed to offset 100% of the mortgage costs against their property income. From 2017/18 the amount of mortgage interest that will be allowed to be offset against property income will be reduced to 75%. There will be a further reduction of 25% each year until 2020/21 when no allowance will be made to offset mortgage interest against property income in order to calculate the tax due.
In place of mortgage interest being a tax-deductible cost will be a 20% tax reducer. This tax reducer is calculated as 20% of the lessor of
- Mortgage interest costs
- Property profit (clearly excluding mortgage interest as a cost)
- Taxable income as a whole
The tax reducer will start at 25% for the tax year 2017/18. This will increase by 25% until 2020/21 when the 20% tax reducer will be set at 100% of the above values.
As you can see HMRC are replacing the mortgage interest cost allowance with the mortgage tax reducer.
Section 24 mortgage interest relief example
John is an employee earning £50,000 and had the following income/costs for property in 2016/17
- £50,000 rental income
- (£20,000) mortgage interest cost
- £30,000 property profit
- £12,000 buy to let tax liability (as a higher rate taxpayer paying 40% tax = £30,000 x 40%)
In 2017/18 the situation will be:
- £50,000 rental income
- (£15,000) mortgage interest cost (reduced from £20,000)
- £35,000 profit
- £14,000 buy to let tax liability (as a higher rate taxpayer paying 40% tax = £35,000 x 40%)
The £14,000 is reduced by the tax reducer as follows:
25% of the 20% tax reducer rate is 5%. The 5% tax reducer rate is the lower of
- £35,000 property profit
- £15,000 mortgage interest
- £85,000 taxable income
Therefore, John receives a tax reducer of £750 (£15,000 X 5%). The tax liability is then:
- £14,000 tax calculated as above less
- £750 tax reducer
- £13,250 tax to pay
As we can see John now pays £1,250 more tax in 17/18 than he did the prior year on exactly the same amount of real profit made.
Basic rate becoming higher rate taxpayers
It is possible that the basic rate becomes higher rate taxpayers. This is because the mortgage interest cost is moved out of the property profits. This means that taxpayers will show a greater paper profit than actually realised. This is all because of the new tax rules for mortgage interest.
Loss of child benefit
If the person was claiming child benefit allowance they would be asked by HMRC to repay this. Child benefit may be claimed by individuals with children that earn typically less than £50,000. Anything above this amount will result in a child benefit reclaim by HMRC using the below formula.
Earned salary less £50,000
——————————— (% result) X Child Benefit Received
Someone earning £55,000 would have a tax charge of:
– 50% = £5,000 (£55,000 less £50,000) divided by 100
– £538.20 = 50% (above) £1,076.40 (52 weeks X £20.70).
Download your buy to let tax guide here, written by our property accountants
Loss of personal allowance
Some of you reading this will see that the person above has a taxable income of £95,000.
However, once the Budget announcement changes kick in (mortgage interest relief) fully the taxable income will be restated as £130,000. This means that the person will lose their personal allowance.
If you earn more than £100,000 then you will be aware that your personal allowances are being eroded by £1 for every £2 of earnings above £100,000.
Someone that earns £120,000 would lose an element of their personal allowance, as follows:
£20,000 Excess of earnings limit = (£120,000 earnings less the £100,000 limit)
£10,000 Reduction to personal allowance (£20,000 excess divided by 2)
£1,850 Revised personal allowance (£11,850 less £10,000)
Loss of pension allowance
You usually pay tax if savings in your pension pot goes above the annual allowance.
This is currently £40,000 a year, provided that you earned this amount of money.
As shown from the Government website from April 2016 you’ll have a reduced (‘tapered’) annual allowance if both the following apply:
your ‘threshold income’ is over £110,000 – this is your income excluding any pension contributions (unless they’re paid as a salary sacrifice by your employer)
your ‘adjusted income’ is over £150,000 – this is your income added to any pension contributions you or your employer make
For every £2 over the above-mentioned amounts, you’ll see a reduction of £1 to your pension contribution allowance.
How to mitigate the impact of Section 24 mortgage interest relief cap
You have read what Section 24 mortgage interest relief cap is. You may now be ready to read our other article on how to mitigate the impact of Section 24 mortgage interest relief cap.