The income you make from rent is also subject to Income Tax. Until recently, if you rented a property you were eligible for a large amount of tax relief, where you could offset mortgage payments against rental income. You were able to subtract the total amount of money spent in mortgage payments from the total amount you had taken in rent, and thereby significantly reduce the overall figure that the income tax was calculated against.
New legislation was created in 2017 however, introducing new, different rules on Income Tax. These new rules have been phased in gradually each year since then, but are now fully implemented for April 2020 and the upcoming tax year.
Going forward, you will no longer be able to deduct mortgage repayments directly from rental income when calculating tax. Instead, you are entitled to tax relief of 20% of your total mortgage payments, which is then deducted from your payable tax. The tax figure it will be subtracted from however, will now be now be calculated from your entire rental income. Whilst the exact amount of tax payable will depend on the tax bracket you fall into (and with your income no longer being offset by mortgage payments, you may well find yourself being pushed into a higher tax bracket) those in higher tax brackets stand to pay a larger amount of income tax. As a rough example based on the 40% tax bracket, the income tax payable could break down as follows:
You earn £10,000 a year in rent, and pay £9,000 in mortgage payments.
Under the old system:
£10,000 Rental Income
- £9,000 Mortgage Payments
= £1,000 taxable income.
40% of £1,000
= £400 total payable Income Tax
Under the new system as of April 2020:
£10,000 Rental Income
40% Tax Bill = £4,000
Tax Relief on Mortgage Payments (20% of £9,000)
= £2,200 total payable Income Tax
As you can see, the tax implications under the new system could see landlords paying a much larger amount of tax than before. This is only a rough example however, and it is important to keep in mind that income tax will be highly variable depending your own financial circumstances. We would always recommend that you seek the appropriate financial advice from a financial adviser to discuss the potential tax implications before deciding to purchase a buy-to-let property.