It wasn't that long ago that investing in property was the smart thing to do as it offered major tax advantages. Due to perks such as mortgage interest tax relief, landlords could be making a substantial annual profit.

But back in 2015, the Government decided to begin a new initiative to reduce financial cost relief for individual and private landlords.

The following four years saw an annual 25% reduction put in place for the amount of mortgage interest you can deduct from your rental income.

Fast forward to 2020 and onward and now the entire sum of your interest payment qualifies for only a 20% tax credit. For some landlords, this might mean paying much more tax than they did in previous years.

Mortgage interest tax relief is the ability for landlords to deduct their mortgage interest costs from their taxable profits. Historically the interest you paid towards a mortgage payment could be deducted from your rental income before you paid tax on it.

However, as of April 2020, Landlords are now taxed on all of their rental income and receive a tax credit worth 20% instead.

So let's dive into this a little further to see what it means for you.

Since April 2020 you have not been able to deduct any of your mortgage interest costs from your rental property before you pay tax.

Instead private and independent landlords are taxed on all of their rental income. After paying the full amount, they are then eligible to claim 20% back as credit.

Let's see what this looks like.

If you are charging £10,000 in rent for your property and are being charged £9,000 in mortgage interest then you will be taxed on the full £10,000 income (depending on your personal tax bracket). After this has been paid then you are able to claim back a 20% tax credit on the mortgage interest. In this example this is 20% of £9,000 so you can claim back £1,800.

For this example, those who are in the lower tax bracket (20%), will have a total tax bill of £200.

For those who are in the higher tax bracket (45%), this will result in a total tax bill of £2,700. This is considerably higher than they would have paid in previous years, when they would not have paid tax on the total rental income.

Yes, you can claim tax relief on mortgage interest. However, the changes over the past few years mean that you will be taxed on all your rental income, and then be able to claim a limited amount of tax credit. Whereas previously, independent landlords were eligible to deduct all mortgage interest payments from their tax bills. The overall tax paid was reduced as they were taxed on profits and not turnover. This particularly benefited those earning higher incomes in the higher tax bracket.

In the 2015 Emergency Budget, the government announced the plan to gradually reduce the percentage that independent landlords were eligible to claim. Over a period of four years, starting in 2017, the percentage decreased by 25% annually. As of April 2020, private landlords are now taxed on all of their rental income. After paying the full amount, they are then eligible to claim 20% back as credit.

So, what does this mean?

The amount that you earn in a year, through the rental property and other forms of income, will determine what tax bracket you fall in and what bill you pay. Those who paid a basic rate tax bill of 20% were unaffected by the 2020 changes. However, those who were entitled to higher and additional-rate tax bills would have seen a sharp increase in what they then owed in their final tax bill.

This initiative was introduced by the government to help make the tax system fairer. The aim was to ensure that landlords with the highest incomes no longer received the most generous tax benefits.

Whilst the government rules are set in place for private landlords and individuals that own their own properties, they do not apply to businesses.

Because of this, some landlords are choosing to set up their own limited companies which will allow them to declare rental income after deducting the mortgage and benefit from the high tax relief. This means that the business owns the property, not the individual or private landlord.

Nevertheless, there are several things to consider before setting up a limited company. It could result in many more layers of complexity and is worth further research to see if it is the right decision for you.

Keep in mind that mortgage rates are considerably higher for businesses than those for private landlords. This could result in you paying more than you would have saved by remaining as a private landlord.

You also have to pay extra stamp duty when you decide to transfer ownership of your rental property to the business. In addition to this, you also take on further taxes such as corporation tax on profits as well as the taxes for the business.

Alternatively, some landlords are now also opting to transition their rental properties into holiday lets. Similarly to limited companies, holiday lets are considered businesses and enjoy the benefits of mortgage interest tax relief.

Unlike second homes or investment properties, mortgage interest costs on your holiday let can be offset against any rental income.

The mortgage you receive for a holiday let property is slightly different to that of a buy-to-let property. The mortgage provider will base the mortgage on an income projection figure. Deposit payments for such mortgages are usually a minimum of 25% as the risks involved are greater than buy-to-let properties. You will also need to consider covering the property costs when it is not in use.

As with the benefits of transitioning your property into a limited company, there are some other aspects to consider if you choose to transition your property into a holiday let.

There are certain requirements that need to be adhered to, for example, your property needs to qualify as a commercially furnished holiday letting in the UK or the EU and pass certain quality conditions.

In addition to this, your property needs to be in use commercially for a minimum of 105 days per year, with a maximum stay of 31 days. It also needs to be available to be used commercially for 210 days per year.

So there you have it. The world of mortgage interest tax relief can be confusing and overwhelming. The new rules and legalities having added further confusion to the mix. But hopefully, this article answers the question of "what is mortgage interest tax relief?"

In short, mortgage interest tax relief is the ability for landlords to deduct their mortgage interest costs from their taxable profits. Whilst previously all landlords were profiting from this, nowadays, it is only really those that transition into limited companies and holiday lets that are reaping the same rewards.