Stress-Free Tax Filing For Landlords

Author: Banin Oozeerally, Associate Director

It’s tax filing season, so now’s a great time to recap the tax rules on mortgage interest for residential properties for individual landlords. Some of you may have switched mortgage products over the last 18 months. Or perhaps you’ve increased borrowings to finance a personal project. Either way, it’s vital to establish the correct amount you can claim on your tax return. Let’s take a closer look…

If you’re a landlord, understanding the intricacies of mortgage interest relief on your rental properties can be challenging. There are various methods to calculate your rental profits, plus specific rules on claiming mortgage interest. In this guide, we’ll break down the key points and help you confidently navigate the tax maze. Whether you’re a seasoned property owner or just getting started, this blog aims to make your life easier.

Cash and accrual basis
You can use two methods to calculate your rental profits:
– Cash basis: record money you receive and pay in the tax year – no capital allowances (full deduction allowed) except for cars. 
– Accrual basis: record income and expenses you are entitled to or owe – usual rules for capital allowances apply.
You automatically qualify for the cash basis method if your rental income for all properties is below £150,000 unless you opt-out. You can review this on an annual basis. 

Mortgage interest
Since April 2020, landlords can only claim 20% basic rate tax credit for mortgage interest and the incidental costs of obtaining a loan. Any unrelieved finance costs are carried forward.

The rules in working out the eligible mortgage interest are tricky. You should monitor your mortgage statement and any changes in loan amount, interest rate and loan costs. In addition, your property must be let on a commercial basis, meaning you charge a rent close to the market rate and intend to make a profit.  

Start of rental business 
If the loan does not exceed the property’s market value when you first let it out, you can claim the full amount of mortgage interest.

For example, Sam bought a property for £200,000 in 2015. It was his main home until he moved in with his girlfriend in March 2021. The property was worth £250,000 (including furniture and fixtures), and he had a mortgage of £170,000 then. Sam switched to a buy-to-let mortgage and borrowed an extra £10,000 for a car. The total loan of £180,000 was still less than the property’s market value of £250,000. Therefore, he could claim the full mortgage interest as a 20% tax reducer.

Additional borrowings 
If you increase the loan on your rental property, the interest on the extra amount will be eligible mortgage interest where that amount is only used for your rental business, and the loan does not exceed the value of your property when you started renting it out.

For example, Sam’s property was worth £300,000, and his mortgage was £175,000 in January 2023. He borrowed another £50,000, making his loan £225,000. This is lower than the property value of £250,000 in March 2021. He spent £30,000 renovating his rental property and £20,000 on his wedding. Only £30,000 was used for his rental business, which meant only 205/225 of his mortgage interest were eligible business costs. 

The cash basis and the mortgage interest restriction
This little-known rule may reduce your mortgage interest claim on the cash basis.

Suppose the total business loans (L) at the end of the tax year are higher than the total property values (V) when these were first let out (plus any capital expenditures not deducted in the calculation of the rental profits). In that case, the allowable finance costs are restricted to interest paid x V/L.

For example, Sid bought a property for £300,000 on a 100% interest-only mortgage (L) in August 2018. He borrowed an additional £10,000 in May 2022 to undertake renovation works, which did not qualify as capital expenditures. The value (V) remained at £300,000. If the total finance charge is £6,000, the amount eligible for relief at 20% would be:

£6,000 × £300,000    =     £5,806
          £310,000

Some say this restriction is unfair and should be removed for those who use the cash basis. 

Summary 
To claim mortgage interest on rental property, you must be careful and keep good records. HMRC can charge penalties and interest for inaccurate payments and tax returns. If you are unsure about anything, please get in touch.