Why are rents soaring? Should we blame the tax system?

Tom is a 45% taxpayer who moved house and rents out his old property.
His rental income after general expenses is £12,000 a year. He pays £8,500 a year in interest on the mortgage on his old property.

In theory, that’s £12,000 income minus £8,500 of interest expense, which is £3,500 of ‘profit’. Fair enough.

But the tax system sees it entirely differently. On his £12,000 income, he pays tax at 45%, which is £5,400. Note this is not 45% on the ‘profit’ element of £3,500.

The taxman gives him a 20% tax credit for his mortgage interest [so £8,500 x 20% = £1,700] off his tax bill, giving a total liability of £3,700 [being £5,400 above minus £1,700]*.

This point is key – Tom is paying tax on the income at 45%, but only receiving 20% relief for his mortgage interest expense**.

In almost all other cases, you get a full tax deduction for your expenses. For example, if you sold toys for £100, but paid £75 to purchase them, you’re taxed on the ‘profit’ of £25.

That leaves Tom with £12,000 rental income, minus £8,500 of mortgage interest, minus £3,700 of tax to pay, meaning at the end of each tax year he is NEGATIVE £200 in terms of his cash position. He’s paying the taxman for the privilege of renting out a property.

So Tom has two options. He could increase rents to cover the shortfall. Or he could sell the house and exit the market, reducing the supply of rental properties – thereby increasing rental prices.

*The actual legislation is more complex than this. The 20% tax credit for interest above is the maximum Tom could get, but it could even be reduced below this.


**No such restriction applies to interest incurred by property companies. The mortgage interest is fully deductible. So if you’re wondering why almost all property investors are using companies and why buy-to-let companies are now the largest single type of business in the UK, this is it.