Relief for mortgages and other financing costs

No tax deduction

For 2020/21 and later tax years landlords of residential properties aren’t entitled to a tax deduction for interest and other finance costs used for their rental businesses. Instead they receive a 20% tax credit. Calculating this can be far from straightforward; the following examples illustrate the basic principles and some of the wrinkles to watch out for.

Tax credit for finance cost

Example 1. Sangita has been a landlord for several years. She makes a profit each year and has no losses or unused finance costs from earlier years. In 2022/23 her rental income is £20,000 and her tax-deductible expenses, £7,000. She also paid interest on two loans used to purchase and improve her let properties on which she paid interest of £14,000 in 2022/23. As a higher rate taxpayer she owes tax of £5,200 on her £13,000 net rental profits. She is also entitled to a tax credit for the loan interest equal to the lesser of 20% of:

• the finance costs (interest), i.e. £2,800 (£14,000 x 20%)
• the rental profit, i.e. £2,600 (£13,000 x 20%)
• her adjusted total income £30,000 (her adjusted income is £85,000) (see The next step ).

In this example the second calculation applies. Sangita has not used the tax credit in respect of £1,000 of the loan interest. She can carry forward the unused finance costs to the following year and make the same calculation to work out how much tax credit she’s entitled to for that year.

Losses and unused finance costs

The position gets trickier when the rental business makes a loss.

Example 2 - part 1. In 2021/22 Alice began a property letting business. The rental income for the year was £4,800 (the property was vacant for some months between tenants) less expenses of £6,000 and mortgage interest of £7,000. She can deduct the £6,000 expenses but none of the mortgage interest to arrive at a loss of £1,200. This can be used against later rental profits. The unused interest of £7,000 can also be carried forward as explained earlier.

It’s important for the landlord to keep a record of losses and unused finance costs separate from each other. These figures are needed for the self-assessment return if they complete one. The record is even more important if they don’t complete annual self-assessment returns.

Example 2 - part 2. In 2022/23 Alice received rent of £11,000. Her expenses are £3,000, plus mortgage interest of £9,500. Alice’s rental income profit is therefore £8,000 but this is then reduced to £6,800 by the £1,200 loss brought forward before the tax credit for interest is worked out. For this example we’ve assumed it is 20% of the rental profit of £6,800. This means Alice can carry forward unused finance cost to the next tax year of £9,700 (£7,000 brought forward plus £2,700 unused for 2022/23 (£9,500 - £6,800)).

The figures can soon get messy and keeping a tight rein on them is important and will become more so when Making Tax Digital begins for landlords in April 2024.