If you let out a residential property, you can't simply knock your mortgage interest off your rental income any more. Instead you get a tax credit worth 20% of your finance costs. It sounds like a small wording change, but for higher-rate taxpayers it can mean a noticeably bigger bill.
This guide walks through how that 20% basic-rate tax reduction actually works for 2025/26. We'll cover what counts as a finance cost, the "lowest of three" rule HMRC uses to size the credit, a full worked example, and what happens when the credit can't all be used in one year.
It's written for individual landlords running a buy-to-let or a small portfolio in their own name. If you want the background on why the rules changed, that's the separate Section 24 story; here we're focused on the calculation itself.
What is mortgage interest tax relief for landlords?
For residential lets held by an individual, mortgage interest and other finance costs are no longer an allowable expense. Instead you get a tax reduction equal to 20% (the basic rate of Income Tax) of those finance costs, applied after your tax is worked out. This is sometimes called the finance cost restriction.
That capsule hides a lot of mechanics, so let's build it up step by step.
How did the old system work, and what changed?
Until 2016/17, a landlord deducted mortgage interest in full from rental income before working out tax. A higher-rate taxpayer effectively got relief at 40%.
From 6 April 2017 the deduction was phased out and replaced with a basic-rate tax credit. The change was tapered over four years, and from 6 April 2020 it has been fully in place. So for 2025/26 you get no deduction for finance costs and instead a 20% tax reduction on them.
The headline effect is twofold. Your taxable rental profit looks higher, because the interest no longer comes off it, and the relief you get back is capped at 20% no matter what tax band you sit in.
What counts as a finance cost?
The restriction covers more than just the headline mortgage interest. According to HMRC, finance costs include:
- interest on mortgages, loans (including loans to buy furnishings) and overdrafts
- alternative finance returns
- fees and any other incidental costs of getting or repaying mortgages and loans
- discounts, premiums and disguised interest
So a remortgage arrangement fee, for example, falls into the 20% credit bucket rather than being a straight deduction. Repairs, letting agent fees, insurance, ground rent and similar running costs are unaffected and still come off your rental income in the normal way.
If a single loan covers both a residential let and, say, a commercial unit, HMRC expects you to apportion the interest on a reasonable basis and only restrict the residential share.
How is the 20% tax credit calculated?
This is the part people get wrong. The credit is not always 20% of your full mortgage interest. It is 20% of the lowest of three figures:
- Finance costs for the year (plus any costs brought forward from earlier years)
- Property business profits for the year, after any brought-forward losses
- Adjusted total income that exceeds your personal allowance, ignoring savings and dividend income
The rule exists so the credit can never reduce your tax by more than the tax actually due on your property profits, and never wastes relief against income covered by your personal allowance.
For most landlords with a healthy profit, the lowest figure is simply the finance costs, so the credit lands at the full 20% of the interest. But if your property made little or no profit, figure two bites and part of the relief is held over instead (more on that below).
The basic rate used is 20% for 2025/26, the same rate that applies across England, Wales and Northern Ireland. Scotland's separate Income Tax bands don't change this credit; it's fixed at the UK basic rate.
Worked example: a higher-rate landlord in 2025/26
Illustrative example. Priya is employed on a salary of £45,000. She also lets one flat, receiving £14,000 in rent, with £6,000 of mortgage interest and £1,500 of other allowable expenses (agent fees, insurance, minor repairs) in 2025/26.
First, her taxable rental profit. Finance costs are no longer deducted, so:
| Rental calculation | Amount |
|---|---|
| Rental income | £14,000 |
| Less other allowable expenses | −£1,500 |
| Taxable property profit | £12,500 |
Her total income is therefore £45,000 + £12,500 = £57,500.
Now her Income Tax before the finance-cost credit, using 2025/26 bands:
| Band | Income in band | Rate | Tax |
|---|---|---|---|
| Personal allowance | £12,570 | 0% | £0 |
| Basic rate | £37,700 | 20% | £7,540 |
| Higher rate | £7,230 | 40% | £2,892 |
| Tax before credit | £10,432 |
Next, the finance-cost credit. It's 20% of the lowest of:
- finance costs: £6,000
- property profit: £12,500
- adjusted total income above the personal allowance: £57,500 − £12,570 = £44,930
The lowest is the £6,000 of finance costs, so the credit is £6,000 × 20% = £1,200.
Her final Income Tax is £10,432 − £1,200 = £9,232.
Under the old full-deduction method, her interest would have come off the rent first (profit £6,500, total income £51,500) and her tax would have been about £8,032. The restriction costs her roughly £1,200 more, because the slice of interest that used to save tax at 40% now only saves it at 20%. That gap is the real-world impact of the rule for higher-rate landlords.
You can sanity-check the band maths for your own figures with our income tax calculator before you file.
What happens if the credit can't all be used this year?
If figure two or three is lower than your finance costs, the credit is based on that lower figure and the unused interest isn't lost. The excess finance costs are carried forward to set against the credit calculation in a future year.
This commonly happens when a property makes a loss or only a small profit, so there's little or no profit for the 20% to bite against. HMRC's own guidance shows balances being carried forward and added to the next year's finance costs until they can be relieved.
Illustrative example. Say a landlord has £9,000 of mortgage interest but only £2,000 of property profit in a year. The credit is based on the lower £2,000 (giving £400), and the remaining £7,000 of finance costs carries forward to add to next year's interest. There's no time limit on the carry-forward while you still run the property business.
Who is not affected by the restriction?
The 20% credit rule applies to individuals, partnerships of individuals, trustees and personal representatives letting residential property. A few situations sit outside it:
- Limited companies. A company that holds buy-to-let property deducts mortgage interest in full against its profits in the normal way, then pays Corporation Tax. This is one reason some landlords look at incorporating, though it brings its own costs and is rarely a slam-dunk.
- Commercial property. Interest on loans for commercial lettings is still fully deductible.
- Furnished holiday lettings. The separate FHL tax regime was abolished from 6 April 2025. Holiday lets are now taxed as ordinary property income, so their finance costs fall under the same 20% restriction as any other residential let from 2025/26 onwards.
Whether moving a portfolio into a company actually saves tax depends on your income, your borrowing and your plans for the properties. It's worth modelling properly rather than acting on a rule of thumb, and our tax advisory team can run the numbers with you.
How do I report finance costs to HMRC?
You report your residential finance costs in the property section of your Self Assessment return. There's a dedicated box for the finance costs that qualify for the basic-rate reduction, separate from your other allowable expenses, and HMRC applies the lowest-of-three calculation when it works out your tax.
Keep clear records of your interest and any qualifying fees, and note any amounts carried forward, so the figures reconcile year to year. If you run several properties, remember they all sit within a single UK property business, so the profits and finance costs are pooled across them.
For more on the wider landlord tax picture, including allowable expenses, the property allowance and Self Assessment deadlines, see our hub for landlord accounting.
Frequently asked questions
Is landlord mortgage interest still tax deductible in 2025/26?
Not as a deduction from rental income. For residential lets held by individuals, mortgage interest gives a basic-rate tax credit worth 20% of the interest instead. It reduces your tax bill rather than your taxable profit.
How is the 20% mortgage interest tax credit calculated?
The credit is 20% of the lowest of three figures: your finance costs for the year, your property business profit, or your adjusted total income above the personal allowance. For most profitable lets the lowest figure is the finance costs, so you get 20% of the full interest.
Why does the finance cost restriction increase my tax bill?
Because your mortgage interest no longer reduces your taxable rental profit, your total income looks higher. That can push you into the higher-rate band, and the relief you get back is capped at 20% rather than your marginal rate. Higher and additional-rate landlords feel this most.
Does the 20% restriction apply to limited company landlords?
No. Companies deduct mortgage interest in full against their profits before Corporation Tax. The 20% credit only applies to individuals, partnerships of individuals, trustees and personal representatives.
What happens to mortgage interest I can't use this year?
If your property profit or adjusted total income is too low to use all the relief, the unused finance costs are carried forward to a later tax year and added to that year's costs. There's no time limit while the property business continues.
Do holiday lets still get full mortgage interest relief?
No. The furnished holiday lettings regime was abolished from 6 April 2025. From 2025/26 holiday lets are taxed as ordinary residential property income, so their finance costs fall under the same 20% restriction.
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Key takeaways
- For 2025/26, individual landlords get a 20% basic-rate tax credit on residential finance costs, not a deduction.
- The credit is 20% of the lowest of finance costs, property profit, or adjusted total income above the personal allowance.
- Unused finance costs carry forward with no time limit.
- Companies, commercial property and (until April 2025) holiday lets sit outside the rule; holiday lets now fall inside it.
Want to know whether the finance cost restriction is costing you more than it should, or whether incorporating makes sense? Book a free call with a Zmartly accountant and we'll model your position properly. Start at our landlord accounting page.
