Letting property – tax treatment and planning considerations

Letting property continues to be a common form of investment, but the tax regime for landlords has become progressively more complex and, in many cases, less favourable. Understanding which costs are deductible, how profits are calculated and how future tax changes may affect returns is essential when reviewing the viability of a rental business.

Deductible expenses and taxable rental profits

When calculating the taxable profits of a property rental business, expenses incurred wholly and exclusively for the purposes of the letting business are generally deductible, provided they are revenue in nature rather than capital.

Examples of typical deductible expenses include:

• Letting agent and management fees
• Insurance premiums
• Repairs and routine maintenance
• Utility bills and council tax (where paid by the landlord)
• Legal and professional fees relating to the letting
• Advertising and tenant-finding costs

These deductions reduce the landlord’s net rental profit, which is then taxed at the landlord’s marginal rate of income tax.

Finance costs – restriction for residential landlords

A major exception to the general deduction rule applies to finance costs for residential property landlords. These include:

• Mortgage interest
• Loan arrangement fees
• Interest on loans used to purchase or improve rental property

Such costs are not deductible when calculating rental profits. Instead, landlords receive a tax reducer equal to 20% of the disallowed finance costs.

This reducer:

• Reduces the landlord’s income tax liability, rather than their taxable income
• Is restricted to the amount of tax due on the rental profits
• Cannot create or increase a loss

For higher and additional rate taxpayers, this restriction can significantly increase the effective tax burden and may result in tax being payable even where the rental business is cash-flow negative.

Capital expenditure versus revenue expenditure

A key distinction in property taxation is between capital expenditure and revenue expenditure.

• Capital expenditure (such as extensions, structural improvements or adding new facilities) is not deductible against rental income, but is usually allowable when calculating any capital gain on disposal
• Revenue expenditure (such as repairs that restore the property to its original condition) is deductible against rental income

The boundary between repairs and improvements is not always clear, particularly where work is extensive or modern materials are used. HMRC often scrutinise such claims, so careful classification and documentation are important.

Capital allowances and furnishings

Capital allowances are generally available only in respect of commercial property, where qualifying plant and machinery is installed.

For residential property, capital allowances are not available. However, landlords can claim a revenue deduction for replacing domestic items, such as:

• Furniture
• White goods
• Carpets and curtains

This relief applies only to the replacement of existing items, not to the initial furnishing of a property.

Rent-a-Room relief and the property allowance

There are two important reliefs for individuals receiving relatively modest property income.

Rent-a-Room relief

Where an individual rents out a furnished room in their only or main residence, the Rent-a-Room scheme provides a tax-free allowance of £7,500 per year.

• If gross receipts do not exceed £7,500, no tax is payable and no reporting is required
• If receipts exceed £7,500, the landlord can choose whether to:
• • Pay tax on the excess over £7,500; or
  • Opt out of the scheme and pay tax on profits in the normal way after deducting expenses

Property allowance

A separate £1,000 property allowance allows individuals to receive small amounts of property income tax-free. This is often used where income is incidental, for example:

• Renting out a driveway parking space
• Occasional short-term lets

The allowance cannot be combined with a deduction for expenses, so it is most useful where costs are minimal.

Practical planning points for landlords

Cash basis versus accruals basis

For unincorporated property businesses with turnover up to £150,000, the default method of calculating taxable profits is the cash basis. Under this approach:

• Income is taxed when received
• Expenses are deducted when paid

Some landlords may prefer the accruals basis, which matches income and expenditure to the period to which they relate, regardless of when cash changes hands.

If you wish to elect out of the cash basis for 2024/25, the election must be made by 31 January 2027.

Rental losses

Any rental losses should be claimed and recorded, as they can be carried forward and set against future profits from the same rental business. Losses cannot generally be set against other types of income.

Rent-a-Room planning

If gross Rent-a-Room income exceeds £7,500, it is important to calculate whether it is more tax-efficient:

• To pay tax only on the excess over £7,500; or
• To opt out of the scheme and deduct actual expenses instead

You are free to choose whichever method produces the lower tax liability.

Abolition of the Furnished Holiday Let (FHL) regime

The abolition of the FHL regime from 6 April 2025 has significantly affected many landlords.

Former FHLs are now subject to the standard residential letting rules, meaning:

• Finance costs are no longer deductible, instead being restricted to the 20% tax reducer
• Business Asset Disposal Relief and other CGT reliefs are no longer available on disposal

Landlords should ensure they have budgeted for higher income tax and CGT liabilities, particularly where borrowing is involved.

Future tax increases and business viability

Income tax rates on property income are due to increase by 2 percentage points from 6 April 2027, to:

• 22% for basic rate taxpayers
• 42% for higher rate taxpayers
• 47% for additional rate taxpayers

Landlords should review whether their letting business will remain viable under these rates, especially where the property was previously an FHL and is also affected by the finance cost restriction.

Making Tax Digital for Income Tax (MTD IT)

MTD IT is being phased in for landlords from 6 April 2026. Affected landlords will be required to:

• Keep digital records
• Submit quarterly updates to HMRC
• File an end-of-year finalisation

Preparation should begin well in advance to avoid compliance issues. Further details are covered in the Sole Traders section.

Private Residence Relief (PRR)

What PRR does

Private Residence Relief (PRR) reduces or eliminates Capital Gains Tax (CGT) on the sale of your main home. In many cases, PRR reduces the taxable gain to nil, meaning no CGT is payable.

PRR applies to:

• Periods during which the property was occupied as your main residence; and
• The final 9 months of ownership, regardless of actual occupation

The final period is extended to 36 months where the owner is:

• Disabled (or their spouse); or
• Moving into a care home

Periods of deemed occupation

Certain absences from the property can still qualify for PRR as deemed occupation, including:

• Periods working full-time abroad
• Certain periods of employment-related absence

Conditions apply, and advice should be taken where long absences are involved.

Evidence of occupation

To qualify for PRR, you must show that you occupied the property with the intention of living there as a home, with a degree of permanence.

HMRC frequently challenge PRR claims, particularly where occupation was short-term or intermittent. Evidence may include:

• Utility bills
• Council tax records
• Electoral roll registration
• Driving licence address (DVLA)
• Correspondence sent to the property

Multiple residences and PRR elections

Where an individual owns more than one property and actually uses more than one as a home, it may be possible to make a PRR election nominating which property is treated as the main residence for CGT purposes.

The election must be made within strict time limits and can be a valuable planning tool where property values differ significantly.

Planning points for PRR and CGT

• Ensure you retain sufficient evidence of occupation, especially where PRR will only apply for part of the ownership period
• Couples should consider joint ownership of properties that do not qualify for PRR, to benefit from:
• • Two annual CGT exemptions; and
  • Potentially lower CGT rates

60-day CGT reporting deadline

If a residential property does not qualify fully for PRR and CGT is payable on disposal:

• A CGT property return must be filed within 60 days of completion
• The CGT must also be paid within that 60-day period

This is a tight deadline. To ensure compliance:

• Keep full records of purchase costs, enhancement expenditure and selling costs
• Retain documentation supporting any PRR claim

Good record-keeping allows the taxable gain to be calculated promptly, reducing the risk of late filing penalties and interest.

Final thoughts

Property taxation is an area of frequent change and increasing complexity. The combination of restricted deductions, rising tax rates and enhanced reporting obligations means that landlords and homeowners alike should review their position regularly.

Whether letting property as an investment or selling a former home, early planning and accurate records are essential to minimise tax liabilities and avoid costly compliance failures. Professional advice should be sought where significant sums are involved or where the tax position is unclear.