In the UK, you cannot deduct your full mortgage payment as an expense when calculating tax on your rental income. However, you may be able to deduct part of the mortgage interest. Here’s a detailed explanation:
1. Mortgage Interest Relief (Current Rules)
You can no longer deduct mortgage interest fully as a rental expense. Instead, the UK now offers a basic-rate tax credit for mortgage interest on rental properties. Here's how it works:
- You can no longer claim mortgage interest payments as a direct expense.
- Instead, you receive a tax credit at the basic tax rate of 20% for the interest part of your mortgage. This credit is applied after your rental profits are calculated and taxed.
How the Tax Credit Works:
- If you're a basic-rate taxpayer (20%), this change doesn't affect you much, as the tax credit is applied at the same rate you're taxed.
- If you're a higher-rate (40%) or additional-rate taxpayer (45%), this change reduces the tax relief you can claim. You used to be able to deduct the full interest amount at your tax rate, but now you only get a 20% credit.
2. Mortgage Payments: Principal vs. Interest
It’s important to understand that your monthly mortgage payment is made up of two parts:
- Principal: The portion that goes toward reducing the loan balance.
- Interest: The portion that goes toward paying interest to the lender.
While mortgage interest qualifies for the 20% tax credit, mortgage principal repayments (the part of the loan you're paying off) do not qualify as an allowable expense for tax purposes. So, you cannot deduct the entire monthly mortgage payment—just the interest portion for tax relief.
Tax on Rental Income in the UK: Homeowners' Guide
3. How the Tax Calculation Works:
Let’s say you have the following:
- Rental Income: £15,000 per year
- Allowable Expenses: £5,000 (including maintenance, letting fees, insurance, etc.)
- Mortgage Interest Paid: £4,000
- Mortgage Principal Repayment: £6,000 (not deductible)
Step 1: Calculate Taxable Rental Income
Rental income (£15,000) - Allowable expenses (£5,000) = £10,000 taxable income.
Step 2: Calculate Tax Owed (Assuming Higher Rate Taxpayer)
Assuming you're in the 40% tax bracket, you would pay:
- £10,000 taxable rental income x 40% = £4,000 tax.
Step 3: Apply 20% Mortgage Interest Tax Credit
You’ve paid £4,000 in mortgage interest, so you can claim a 20% tax credit on that:
- £4,000 x 20% = £800.
Final Tax Owed:
- £4,000 (tax owed on rental profits) - £800 (mortgage interest tax credit) = £3,200 tax owed.
4. Other Considerations:
- If you're a basic-rate taxpayer (20%), the tax credit on mortgage interest won’t affect your tax liability significantly since the credit is applied at your tax rate.
- If you're in the higher (40%) or additional rate (45%) tax bands, the restriction on mortgage interest relief can increase your tax bill.
- Financial & Tax Considerations When Buying a House
Summary:
- No, you cannot deduct your entire mortgage payment (both principal and interest) as an expense in your tax calculation.
- You can only claim a 20% tax credit on the mortgage interest portion, not the principal repayment.
- This change has the most significant impact on higher-rate taxpayers, who used to be able to deduct full mortgage interest at their marginal tax rate.
If you have a complex situation or significant rental income, it’s advisable to consult a tax professional or accountant to ensure you’re handling your property income and mortgage relief efficiently under current UK tax rules.