A point to be aware of is that (disregarding potential eventual inheritance tax) there are two main taxes: income tax on rent, and if you sell the property (or even give it away!) it will be assessed for capital gains, as Islay and Darren point out. Where you have to be careful is to work out which costs fall under which regime.
Under the current tax regime (which can change!:)
The net profit each year is treated as income and would be taxed as such. The profit is your rental income less acceptable costs: buildings insurance, the interest charged on loans for purchase or improvement of the property, agents fees, and either the actual costs of maintenance, or a fixed 10% of the rental income for maintenance. Some expenditure would be allowable against that year's income; for example, the replacement of a cooker, or the repainting or recarpeting of a room.
However, some expenses will not be treated as income, and those are any expenses which are regarded as improving the property. These expenses cannot be claimed at the time, though they will reduce the eventual capital gain. For example adding a loft conversion or installing central heating where there was none before would both be regarded as improving the property and could not be claimed as an expense.
As an example, imagine a property bringing in £6000 pa in rent. If agents fees are £900, insurance is £300 and the interest on the mortgage is £2000, the taxable profit would be just £2800. If you now spend £1000 on redecoration and a further £8000 on converting an outhouse into an extra room, then your taxable profit would be £1,800, because only the redecoration costs would be taken into account. When you sell the house, though, the profit (ie sale price less purchase price, with costs taken into account) will be reduced by that £8000 spent on improvement.
And, no, you can't reduce the tax by making pension contributions (unless you use other income to justify the tax) because rental income does not qualify as earned income for pension purposes. | 12.10.10 @ 00:29