Income Tax on Rental Profits

When you let out a property, the rental income you receive is subject to income tax. However, the tax is calculated on your profit, not the gross rent. Your profit is rental income minus your allowable expenses.

Calculating Rental Profit

Rental profit = gross rental income − allowable expenses. It's crucial to understand what counts as an allowable expense. The key rule: expenses must be incurred wholly and exclusively for the purpose of the lettings business.

Allowable expenses include:

• Letting agent fees and rent collection charges
• Repairs and maintenance (fixing broken items, redecorating)
• Buildings and contents insurance
• Property management fees
• Accountancy and bookkeeping costs
• Mortgage interest (subject to Section 24 treatment)
• Council tax and water rates
• Utility bills if you're responsible
• Travel expenses to the property

NOT allowable: mortgage capital repayment, improvements (new kitchen, extension), CGT, income tax itself.

Section 24: Mortgage Interest Restriction

Since April 2020, Section 24 of the Income Tax Act has restricted how landlords can claim mortgage interest. Instead of deducting it from rental income, you receive a 20% basic rate tax credit on the mortgage interest paid. This applies to all individual landlords with buy-to-let mortgages, regardless of their tax band.

For a higher-rate (40%) or additional-rate (45%) taxpayer, this creates a mismatch: you pay income tax at 40% or 45% on rental profits, but only get a 20% credit on mortgage interest. This is one reason many investors have moved to limited companies, which can deduct mortgage interest fully against corporation tax profits.

Wear and Tear Relief

The old 10% wear and tear allowance (claiming 10% of rent as depreciation) was abolished from April 2016. It has been replaced with actual replacement relief: you can claim the actual cost of replacing furnishings and fittings, but only when you actually replace them. This applies only to furnished holiday lettings and some other specific lettings; unfurnished properties get no relief.

Income Tax Rates 2025/26

Your rental profit stacks on top of employment income. A £40,000 salary plus £15,000 rental profit means £5,000 of the rental income is taxed at 40% (the excess over the basic rate threshold).

Capital Gains Tax on Property Disposals

When you sell an investment property, you're liable for Capital Gains Tax (CGT) on the profit made since purchase. The gain is calculated as sale price minus original purchase cost, minus allowable capital improvements, minus reliefs.

CGT Rates (2024/25 onwards)

After the October 2024 Budget, property disposals are taxed at:

• 18% for basic rate taxpayers (on non-residential property)
• 24% for higher and additional rate taxpayers (on non-residential property)
• 20% and 40% respectively for residential property (still at pre-Budget rates for now)

The annual exempt amount for 2024/25 is £3,000. This is the amount of gain you can make tax-free each year. Above that, gains are taxed.

Principal Private Residence Relief (PPR)

If you've lived in a property as your main home at any point, you may qualify for PPR, which exempts that period of ownership from CGT. Once you let it out, PPR is lost for future years. A complex relief period existed (up to 9 months after moving out), but this depends on when you ceased to occupy it.

Letting Relief

Letting relief was significantly curtailed from April 2020. It now applies only if you lived in the property with the tenant at the same time (e.g., a lodger arrangement). For standard buy-to-let where you don't occupy the property, there is no letting relief.

60-Day Reporting and Payment Rule

This is critical: within 60 days of completion of the sale, you must report and pay any CGT due on residential property. Failure to do so incurs automatic penalties. Non-residential property can be reported in your annual tax return, but residential must be reported and paid within 60 days.

Reducing Your CGT Liability

• Capital improvements: cost of a new kitchen, extension, or loft conversion adds to your base cost and reduces the gain
• Timing disposals: if you have unused annual exemptions, spacing sales across tax years allows you to use multiple exemptions
• Spouse's allowance: if married, hold property in joint names so each spouse gets an exemption
• Losses: capital losses from other disposals can offset property gains

Stamp Duty Land Tax (SDLT)

SDLT is paid by the buyer when purchasing a property. As an investor, you'll pay the higher rates applicable to additional properties and investment purchases.

SDLT Rates for Investment Properties (2025/26)

The additional property surcharge of 3% applies to most investment purchases. The multiple dwellings relief (MDR), which previously allowed investors purchasing multiple properties to avoid some of this surcharge, was abolished from April 2024 for all new purchases.

Limited Company Purchases

When a company purchases residential property above £500,000, a flat rate of 15% SDLT applies (with narrow exemptions). This can be beneficial for larger portfolios, but the company structure itself has other implications (see below).

Inheritance Tax (IHT)

If you own investment properties in your personal name, they form part of your estate for Inheritance Tax purposes. IHT is charged at 40% on the value above your nil-rate band.

The current nil-rate band is £325,000 (unchanged since 2009). If you pass property to direct descendants (children, grandchildren), you get an additional Residence Nil-Rate Band (RNRB) of £175,000, increasing your total allowance to £500,000.

A common misconception: Business Property Relief (BPR) does NOT apply to residential property letting. It only applies to active trading businesses. Holding residential properties as an investment does not qualify for BPR relief.

IHT Planning Options

• Gifting: gifts made more than 7 years before death are outside the estate; gifts within 7 years are tapered
• Trusts: using discretionary trusts can be efficient but is complex; takes planning
• Insurance: life insurance can cover the expected IHT bill, ensuring beneficiaries aren't forced to sell property to pay tax

VAT on Residential Lettings

Residential lettings are exempt from VAT. You cannot charge VAT on rent or reclaim VAT on expenses related to a residential let. This is different from commercial property lettings, which are also exempt but can be opted into VAT, allowing you to reclaim VAT on costs (useful if your tenants are VAT-registered businesses paying you VAT).

Annual Tax on Enveloped Dwellings (ATED)

If a company (rather than you personally) holds residential property valued above £500,000, you must pay the Annual Tax on Enveloped Dwellings (ATED). This is a separate annual tax, not related to corporation tax.

ATED rates for 2025/26 depend on valuation: rates range from £3,500 (properties valued £500k–£1m) up to £18,000+ for properties over £20m. Exemptions exist for genuine lettings businesses and other narrow cases, but most property companies will pay ATED.

Limited Company Tax Position Summary

Many investors structure buy-to-let as a limited company to avoid the Section 24 mortgage interest restriction. Here's the trade-off:

Advantages: Corporation tax at 19% or 25% (depending on profit level) on rental profits; full deduction of mortgage interest; no restriction like Section 24.

Disadvantages: ATED if property value exceeds £500k; stamp duty at 15% on purchases over £500k; dividend tax at 7.5% (basic rate) or 39.35% (higher rate) when extracting profits; cannot use PPR relief (no relief ever); must file company accounts and tax returns; some remortgage lenders are reluctant or charge more.

The company structure works best for higher-rate (40%+) taxpayers with significant mortgages, or where the 15% SDLT rate is offset by scale. For basic-rate taxpayers or low-mortgage portfolios, personal ownership often remains simpler and cheaper.

Putting It All Together: Tax-Aware Deal Assessment

Understanding these taxes is essential for assessing whether a deal truly makes sense financially. Consider:

• Does the rental yield, after all allowable expenses and income tax, justify the capital required?
• If you're a higher-rate taxpayer, is a company structure worth the complexity and ATED cost?
• When you exit, what will CGT and the 60-day payment obligation cost?
• Are there capital improvements you can make now to reduce future CGT?
• Does SDLT and the additional property surcharge compress your profit in year one?

By integrating tax planning into your deal analysis from the start, you avoid unpleasant surprises and build a genuinely profitable portfolio.

Finding Tax-Efficient Deals with DealMind

The best investment strategy combines sound tax knowledge with the ability to find properties that offer real profit potential. That's where DealMind comes in. Our platform connects you with motivated sellers and off-market opportunities, helping you identify deals with enough margin to account for taxes and still achieve strong returns.

Whether you're building a personal portfolio or structuring through a company, understanding your tax position first means you can use DealMind to find properties that actually work for your situation—not just on paper, but after tax.