According to research from Fidelity 91% of Britons admit they do not understand Capital Gains Tax (CGT) and only 6% could identify the correct annual ‘tax-free’ allowance. Given the few tax concessions on offer it’s important that people consider using their CGT allowance. It could save you up to £5,100 in tax each year.
What is CGT?
CGT is applied to the profit made when you sell or dispose of an asset. CGT applies to a variety of assets, such as second home or high value personal possessions, and particularly to investments like shares and investment funds that grow in value over time. However unlike income tax, CGT does not arise automatically each year as investments grow in value but only when you make a sale. There is currently a single flat rate of 18% applicable to everyone. That means should Joe Average sell a second home he would be taxed at the same rate as a billionaire who sold his ten bedroom mansion. There is no reference at all to what level of income tax you pay. Consequently there is a huge disparity between high rate income tax (now 50% of income) and CGT (18%). This makes deriving an ‘income’ (via capital gains) which is subject to CGT particularly attractive to high rate tax payers as it could potentially save them thousands of pounds in tax per annum.
So what’s this annual allowance you mentioned earlier?
The really good news is that everyone gets an annual CGT allowance each tax year, currently £10,100. This means that you can make capital gains of £10,100 without having to pay tax at all. For investor this is very attractive, again, particularly for high rate income tax payers as it could save them £5,050 in tax per annum (the disparity between them being assessed for income tax at their marginal rate as opposed to CGT while using their annual allowance). But regardless of your income tax position using your annual CGT allowance means that £10,100 of gains are tax free rather than being charged at the CGT flat rate of 18% (meaning a minimum saving of £1,818 pa).
This sounds great but there must be a catch?
Annual allowances can’t be carried over if you don’t use them in a given tax year. So it’s a case of use it or lose it. Also, in order to fully utilise your capital gains tax allowance you will have to sell assets/investments. Unfortunately, you can’t just sell an asset or investment one day and buy it back the next (formerly called bed & breakfasting) for a similar price, so using your allowance while effectively retaining ownership. If you want to buy back exactly the same investment once you have realised its gain then you have to wait at least 30 days.
Is there no other way around it? I’d heard of something called bed & spousing, or have I just made that up?
There are two options open to you, one called ‘bed & ISA’ and the other called ‘bed & spousing’ which I will cover in a future money tip.
So to sum up:
It makes sense to use your CGT allowance where possible (&suitable) each tax year as it could save you thousands of pounds in tax – this is just sensible tax planning. But, as I’ve previously said you should never make an investment solely for tax reasons alone. One other thing you should bear in mind is that the current CGT regime could be changed by future Government action particularly given our huge levels of national debt, but then that could be said about any part of the tax system.