Falling markets and falling investments are rarely welcome, but there are actions you can take that can improve your financial position, and one thing to consider is managing your capital gain tax (CGT) position. This article focuses on some of the more simple, but not to be forgotten, CGT planning opportunities.
Let’s begin with the basics. CGT is a tax on the profit when you sell or dispose of an asset that has increased in value. Disposing of an asset includes selling it, giving it away as a gift, or transferring it to someone else. It is the gain you make that is taxed, not the amount of money you receive. Some investment assets are CGT-free; for example gains within ISA and pension wrappers, UK Government Gilts and Premium Bonds. On other assets, such as shares, OEICs and unit trusts, capital gains are added to your other taxable income to determine the rate of CGT. Gains that fall within your basic rate tax band are taxed at 10% (18% for residential property), and gains that fall within the higher/additional rate tax bands are taxed at 20% (28% for residential property). Individuals have an annual exempt amount which is deducted before determining the taxable capital gains. For the tax year 2020/21 the CGT annual allowance is £12,300.
Things to consider to help manage your CGT:
- Use your annual exemption – As far as possible it is advisable to use the annual exemption each tax year because, if unused, it cannot be carried forward. If the annual exemption is not regularly used you are more likely to reach a point where some of the gains will be subject to tax.
- Spousal exemption – Spouses are taxed separately on their capital gains and each has their own annual exemption. It therefore makes tax sense for an individual to transfer assets into their spouse’s name to make use of that spouse’s annual exemption or possible lower tax rate when planning a disposal.
- Loss relief – disposing an asset that has a loss in the same tax year as an asset with a gain can reduce or mitigate any CGT. Loss relief is particularly relevant immediately following a market downturn. Unlike the annual exemption if you have a net loss in a tax year this can be carried forward for use in future tax years. It is important to keep a record of carried forward losses so they aren’t forgotten. You can claim for a loss by including it on your tax return or by writing to HMRC. You do not have to report losses straight away – you can claim up to 4 years after the end of the tax year in which you disposed of the asset.
- Make a Pension contribution – Paying a pension contribution will increase your basic rate tax band and could mean that a significant part of any taxable capital gain is likely to suffer CGT at a rate of 10% rather than 20%.
CGT can be very complicated and there are a number of considerations beyond the planning mentioned in this article such as calculating the purchase cost of an investment, particularly if purchased a long time ago. Today, the use of modern trading platforms can assist with calculating base costs, separating income and calculating any realised capital gain. One final point is don’t let the tax tail wag the dog. The decision to buy or sell an asset should be based on many factors, however now may be a good time to review your portfolio.