Understanding Capital Gains Tax
While we are all used to paying income tax and even seeing Value Added Tax added to the services we purchase, most of us know far less about Capital Gains Tax – another charge that can have a huge impact on our finances.
Capital Gains Tax (or CGT) is levied when you dispose of an asset that you own and make a profit. The rates you pay can be quite high – up to 28 per cent of the gain you’ve made, so it is sensible to understand how it works so that you can make use of the allowances that help you to pay less of this tax, resulting in you keeping more of your gains.
How Capital Gains Tax works
Many assets that we buy appreciate in value so that when we sell them we get back more than we have paid. Most of these assets, including jewellery, paintings, property and shares, are liable for capital gains tax when sold if they have appreciated in value.
You usually pay tax on the gain that you have made between buying and selling the item (rather than the value of the item), and you can deduct certain costs.
CGT is levied at different rates depending on what you are selling and the income tax rate you pay. Higher and additional rate taxpayers pay CGT 28 per cent if disposing of residential property, and 20 per cent on gains for other chargeable assets.
For basic rate taxpayers it is a little more complicated. You will need to add the profit you have made to your taxable income for the year (minus your tax-free allowance). If you are still within the basic rate band for income tax, which currently ends at £50,270, with the added gain, you pay 10 per cent capital gains tax on your profit. If the gain takes you over the threshold into higher rate tax then you pay the higher rate on any amount above the basic tax rate.
For example, if you sell a picture that you bought for £10,000 for £50,000, you have made a gain of £40,000. The Capital Gains Tax that would be due on that as a higher rate taxpayer would be £8,000. If you were a basic rate taxpayer, the amount due would be £4,000. If the £40,000 gain took you £5,000 above the basic rate threshold, so that you ended up with an annual income of £55,270, you would pay 20 per cent on the final £5,000 of the gain and 10 per cent on the other £35,000.
Allowances and transfers
CGT may seem punishing, particularly if you are selling family assets or suddenly need to release capital for an unexpected expense. However, there are ways to mitigate your tax bill, and some of them are extremely simple.
One of the first things to note is that we all have a Capital Gains Tax allowance. That means you can currently make gains of up to £12,300 in a year without paying any CGT at all. You can also make gifts to a spouse and use their annual allowance.
Some assets do not incur a CGT liability. These include your car and your main residential property as well as assets that are not meant to have a lifespan of more than 50 years such as wine, clocks and boats.
If you receive less than £6,000 for a personal possession you do not need to pay CGT on gains when you dispose of it, while there is a reduced amount payable for possessions sold for between £6,000 and £15,000.
Using an ISA or pension is a great way to ensure you do not pay too much CGT. Shares in either of these tax wrappers can grow without being liable for the tax, and you can put £20,000 into an ISA each year while most of us can put £40,000 into a pension too.
You can also reduce your CGT bill by offsetting losses you have made in a tax year against your capital gains tax liability. So, if you sell shares at a loss, you can put this loss on your tax return to reduce your CGT bill.
Another important thing to note is that Capital Gains Tax allowances are being reduced from next tax year so it makes sense to use any allowances now if you can. The £12,300 allowance is being reduced to £6,000 from April, and then to £3,000 the following year. So if you have an asset to sell, doing so before April could yield rewards.
Likewise, if you have shares outside of an ISA and an unused ISA and CGT allowance, it may be worth selling them outside the ISA to realise the gain and use the allowance, before buying them back inside an ISA to ensure you do not fall prey to further taxation in future.
The rules around CGT are quite complex and, as always, you may want to use an expert to help you to understand what to do. Acting before the end of tax year deadline could reduce your liability significantly.
6th February 2022