Can I offset HMO mortgage interest against rental income?

Landlords operating Houses in Multiple Occupation (HMOs) face specific tax regulations regarding finance costs. Since changes were fully implemented in the UK tax system in April 2020, individual landlords can no longer deduct all mortgage interest costs directly as an expense against their rental income. Instead, they must apply for a basic rate tax reduction (20%) on those costs. This comprehensive guide explains the nuances of the restriction, how it impacts HMOs, and alternative strategies for managing finance costs.

Can I offset HMO mortgage interest against rental income under UK tax law?

The short answer is that the ability to offset HMO mortgage interest against rental income depends entirely on the ownership structure of the property. For individuals owning rental property, including HMOs, the law significantly changed due to the introduction of Section 24 of the Finance Act 2015, which phases out full relief.

Prior to the restrictions, landlords could deduct finance costs (such as mortgage interest) before calculating their taxable profit. Now, this deduction has been replaced by a system of tax credits. Understanding this distinction is crucial for managing the profitability of your HMO portfolio.

The Impact of Section 24 on Individual HMO Landlords

Section 24 introduced the restriction on the deduction of residential property finance costs. Crucially, unless the property qualifies as a Furnished Holiday Let (FHL) or the business operates under specific circumstances, these rules apply equally to standard Buy-to-Let (BTL) properties and HMOs held in a landlord’s personal name.

The restriction means that instead of reducing your gross rental income by the amount of interest paid, you must:

1. Calculate your total taxable rental income (before finance costs).
2. Calculate the income tax due on that figure.
3. Reduce the calculated tax bill by 20% of your total finance costs (interest paid).

This change generally has the most significant negative impact on higher and additional rate taxpayers, as the relief is fixed at the basic rate (20%), regardless of the landlord’s actual tax bracket.

How the Finance Cost Restriction Affects Your Taxable Income

A key consequence of Section 24 is that your declared rental income, for the purpose of assessing your tax bracket, is higher than it was previously, as finance costs are no longer deducted first. This can push some basic rate taxpayers into the higher rate band (40%), even if their net profit remains the same.

For example, if you earn £30,000 in rent and pay £15,000 in interest, your taxable income calculation proceeds as follows:

• Old system: Taxable profit = £30,000 (Rent) – £15,000 (Interest) = £15,000.
• New system (Personal Ownership): Taxable income assessed = £30,000. Tax credit available = 20% of £15,000 (£3,000).

For higher rate taxpayers, the £3,000 tax credit is often substantially less valuable than the relief received under the old system, where they could deduct the £15,000 expense, saving them £6,000 in tax (40% of £15,000).

Limited Company Ownership: The Key Difference

For many HMO investors, the transition to owning property through a Special Purpose Vehicle (SPV) Limited Company has become the most common strategy to regain full interest cost relief. This is because the Section 24 restrictions only apply to individual landlords.

When an HMO is owned by a Limited Company, the mortgage interest and other associated finance costs are typically treated as legitimate business expenses, which are fully deductible against the company’s rental income before Corporation Tax is calculated.

Advantages of Company Ownership for HMOs

• Full Interest Deduction: All mortgage interest can be offset against rental revenue, reducing the company’s taxable profit.
• Corporation Tax Rate: The company pays Corporation Tax on profits, which is currently lower than the higher rate income tax (40%) and additional rate income tax (45%) brackets applied to individuals.
• Flexibility: Profits can often be reinvested or retained within the company, controlling when and how personal income tax (via dividends) is paid.

Considerations and Risks of Using a Limited Company

While the tax benefits are clear, company ownership is not without complexity or cost:

• Mortgage Costs: Limited Company mortgages often have higher interest rates and arrangement fees than personal BTL mortgages.
• Legal and Accounting Fees: Companies must file annual accounts with Companies House and HMRC, often requiring specialist accountant support.
• Stamp Duty: Transferring an existing personally owned HMO into a company structure can incur Stamp Duty Land Tax (SDLT) and Capital Gains Tax (CGT).
• Extraction of Funds: Drawing money out of the company (via salary or dividends) will be subject to personal income tax rates.

Before deciding to switch structures or purchase new HMOs via a company, it is essential to seek professional tax and financial advice tailored to your specific circumstances.

Other Allowable HMO Expenses

While mortgage interest relief is heavily restricted for individuals, most operational costs associated with running an HMO remain fully deductible. These costs reduce your gross rental income before calculating tax liability, even under the Section 24 rules. Allowable expenses typically include:

• HMO Licence fees and associated application costs.
• Insurance premiums (building, contents, public liability).
• Repairs and maintenance (but not improvements, which are capital costs).
• Utility bills (if included in the rent) and Council Tax.
• Letting agent fees and property management costs.
• Legal, accountancy, and professional fees directly related to the letting business.

For detailed guidance on which property expenses are generally allowable, you should consult official resources provided by His Majesty’s Revenue and Customs (HMRC). You can find comprehensive information on how finance costs are restricted by visiting the UK Government’s official guidance on property rental income tax.

People also asked

Can I claim full mortgage interest relief if my HMO is run as a business?

Simply running an HMO actively, even one requiring significant management and licensing, does not automatically exempt you from Section 24 rules if you own the property as a private individual. Full relief is generally restricted to properties held within a corporate structure or those classified as genuine Furnished Holiday Lets, which have specific criteria regarding availability and occupancy.

How does the 20% tax credit mechanism work for higher rate taxpayers?

For higher-rate taxpayers, the restriction means you receive tax relief equivalent to the basic rate (20%) on your finance costs, even though you are paying income tax at 40% (or more). This causes a financial shortfall compared to the previous system, as the 40% liability is calculated on a higher gross income figure, and only 20% of the interest costs are credited back.

Is the interest relief restriction applicable to commercial mortgages?

No. The restrictions introduced by Section 24 apply specifically to interest on mortgages or loans relating to residential dwelling houses. Interest on commercial properties (such as office space or retail units) or genuinely commercial loans taken out for business purposes remains fully deductible against the associated commercial income.

What is the definition of “finance costs” under the new rules?

Finance costs include not just mortgage interest payments, but also interest on loans used to purchase furnishings or repair the property, as well as mortgage arrangement fees and product-specific fees (if the fees are incurred solely to obtain the loan used for the rental property).

Do I have to calculate the tax credit manually?

Yes, individual landlords must calculate the total amount of finance costs incurred during the tax year and enter this figure when filing their self-assessment tax return. HMRC’s calculations will then apply the 20% basic rate tax reduction to your total tax bill. Many landlords rely on specialised property accountants or dedicated accounting software to manage this complex calculation correctly.

Final Considerations for HMO Finance

Navigating the tax landscape for HMOs in the UK requires meticulous planning, especially concerning finance costs. While the ability to directly offset interest against income is severely limited for individual owners, the option of using a Limited Company structure remains a powerful tool for professional landlords seeking tax efficiency.

When considering refinancing or purchasing a new HMO, always model the tax implications under both personal and company ownership scenarios. Given the complexities of Corporation Tax, dividend taxation, and the potential for higher rates and fees associated with Limited Company lending, professional financial advice is essential to ensure compliance and optimise your returns.

Your property may be at risk if repayments are not made. Failure to meet your mortgage obligations can lead to legal action, increased interest rates, additional charges, and ultimately, repossession.