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This case study is based on genuine client work carried out by our practice. Names, figures and identifying details have been changed to protect confidentiality, and the numbers shown are representative of the situation rather than the exact amounts. Your own position will differ.
The scenario
A landlord owns two rental properties. Rents total £24,000 a year. The mortgages cost £11,000 a year in interest. Other costs, letting agent, insurance, repairs, come to £4,000.
They do the sum the way anyone would: £24,000 minus £11,000 minus £4,000 equals £9,000 profit. They expect to pay tax on £9,000.
That is not how it works, and has not since 2020.
Why the arithmetic is not what you think
Finance costs on residential lettings are no longer deductible from rental profit. Instead you get a basic rate tax reducer, worth 20% of the interest, taken off your tax bill at the end.
So the taxable profit is £24,000 minus £4,000, which is £20,000, not £9,000. The £11,000 of interest does not come off the profit at all. You then knock 20% of £11,000, which is £2,200, off the tax due.
For a basic rate taxpayer the two roughly cancel out and little changes. For a higher rate taxpayer it is a real hit: tax on £20,000 at 40% is £8,000, less the £2,200 reducer, leaving £5,800 on an economic profit of £9,000. An effective rate of about 64%.
The trap that catches people
It is worse than a rate rise, because the inflated profit figure counts as income for everything else.
It can push you over £50,270 and into the higher rate band on your salary. It can push you over £60,000 and into the High Income Child Benefit Charge. It can push you towards £100,000 and the personal allowance taper, where the effective rate hits 60%.
A landlord can be pushed into higher rate tax by rental income they never actually received, because the mortgage swallowed it. That is the part people find hardest to believe.
What is worth considering
Check the numbers properly first. A lot of landlords have never seen this calculation done, and the shock is the point at which decisions get made badly.
Incorporation is not a free fix. Companies do still get full interest relief, which is why everyone mentions it. But transferring property to a company is a disposal for capital gains tax and triggers stamp duty, so it can cost tens of thousands up front. It suits some portfolios and is actively wrong for others, and it needs modelling over a realistic holding period, not a rule of thumb.
Ownership share between spouses. If one of you is a basic rate taxpayer and the other is not, how the property is held matters a great deal.
Do not forget it applies to former holiday lets too. The furnished holiday lettings regime was abolished in April 2025, so properties that previously got full interest relief no longer do.
The point of this example
If you are a higher rate taxpayer with a mortgaged rental, your tax bill is calculated on a profit figure that does not exist. Understanding that is the difference between planning and being surprised every January.
If you own rental property and have not had this calculation explained to you, get in touch.
Letting property and unsure of the tax?
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