How to claim mortgage interest as a deduction on rental property accounts?

If you are a landlord or property investor, then understanding the rules around claiming mortgage interest as a deduction on your rental property income is important.

There are different rules for limited companies and individuals who own rental properties personally around mortgage interest tax relief. Limited companies can claim mortgage interest, individuals just receive a 20% reduction from their tax liability.

In this blog we look at the details around tax relief on mortgage interest for both individuals and limited companies.

What is mortgage interest on rental income?

Where residential properties that are rented out are concerned, mortgage interest on rental income refers to the cost you pay to borrow money from a lender to purchase the property you rent out.

How you pay tax and the way mortgage interest is treated for tax purposes has changed in the past few years.

Before 2020, landlords who own and rent properties personally (i.e. not through a limited company) could directly deduct the full amount of mortgage interest from their residential property finance costs before calculating their tax liability.

This deduction is no longer allowed for private landlords who rent property out personally. Now, instead of deducting the entire mortgage interest amount directly from your rental income (and therefore making a significant saving on your tax bill), landlords are only entitled to a 20% tax credit on mortgage interest.

Tax on rental income

Limited company owned properties

Tax on properties owned via limited companies is treated differently as far as tax relief is concerned. For limited companies owning rental property, the entire mortgage interest payment is tax allowable and can be reduced from taxable income and will therefore reduce the company profits and the company's corporation tax bill. This is regardless of whether the Directors and Shareholders are themselves higher rate or additional rate taxpayers.

If you keep the profit inside the company, then there's no more tax to pay. If you want to take profit out of your company and pay yourself personally, you can do this via salaries, dividends or pension payments, and each one would be taxed differently. Seek professional advice from dns accountants on the most tax efficient way to take profit or excess cash from your business.

Personally owned properties

For personally owned properties it is less straightforward as you can't claim your mortgage interest as an expense on rental income on personally owned properties. Instead, HMRC allows a basic rate 20% reduction from your tax liability for any mortgage interest payments and other financing costs.

This credit is calculated based on the lower of three amounts:

• Your total finance costs: This includes all interest payments on loans for the property.

• The net profit of the property before accounting for finance costs: Your rental income minus all allowable other expenses except for finance costs.

• Your adjusted total income for the tax year.

To account for this, you must do the following:

1. Calculate your total rental income for the tax year.

2. Deduct allowable expenses (but NOT mortgage interest) from your total rental income.

3. This gives you your taxable rental income.

4. Calculate the tax due on this amount at your marginal rate and taking into account your personal allowance (the rate of income tax you pay will depend on your total income and will determine if you are a basic rate, higher rate or additional rate taxpayer).

5. Deduct a basic rate tax credit of 20% for your mortgage interest from the tax due, thereby reducing your tax bill.

6. Report everything on your annual self assessment tax return.

7. Pay income tax due.

This is why higher rate taxpayers who personally own rental properties can pay much more tax than if those properties were owned via a limited company.

The way the 20% tax credit is applied can lead to taxable income being higher and taxpayers who would otherwise have been paying tax at the basic rate becoming higher rate taxpayers once the finance costs are disallowed.

Your tax liability depends on your other income and the amount of finance costs that are added back.

You will not know whether the adjustment will take you into a higher rate tax without seeking professional advice.

If you do become a higher-rate taxpayer after arriving at your rental profits, you will lose higher-rate tax relief on your finance costs and could affect any benefits you claim.

It could be beneficial for you to consider owning your rental properties within a limited company to be able to claim more tax relief and reduce your tax bill.

Read our blog Should I buy property through a limited company here.

Commercial properties

For landlords of non-residential/commercial properties, you can deduct the entire amount of mortgage interest directly as an expense from your taxable profit.

Furnished holiday lets

Mortgage interest on furnished holiday lets is currently treated as a deduction from rental income for income tax purposes. However, from April 2025, relief will be given as a 20% tax credit for higher and additional rate taxpayers. This means a reduction in tax relief for individuals from 40% and 45% respectively.

Conclusion

The landscape of mortgage interest tax relief on rental income for buy-to-let landlords has undergone significant changes in recent years. The transition from being able to claim mortgage interest as a fully allowable expense for those who personally own rental property, to a basic rate tax credit has prompted many landlords to reconsider how they own rental property and the impact on their tax liabilities.

Those owning property through a limited company can claim mortgage interest as part of their finance costs and will be able to claim mortgage interest tax relief on the full amount against their rental income.

However, if you are considering setting up a limited company to reduce your tax liability, it’s important to understand what it’ll mean for you. Speak to a tax specialist at dns accountants before you set up the company or transfer property into a limited company.

Call our specialist tax team today to get advice to minimise your tax bill and further information on mortgage interest tax relief. Contact us by calling 03330601807, or email us at enquiry@dnsaccountants.co.uk.

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