What is capital gains tax?
Capital gains tax is a tax payable on the increase in value of a variety of items during the time you have owned or held them. The tax is due when you dispose of them, usually by selling them or giving them away. Examples include items such as a second home, antiques or shares. Certain costs are allowable when working out your chargeable gains, such as the cost of acquiring and disposing of the asset and any expenditure on enhancing the asset`s value.
Annual exempt amount
The current annual amount for exemption is 10,900 for this tax year, rising to 11,000 in 2014/15, in 2015/16 it will be 11,100.
A great tip for higher rate taxpayers who will have to, above their annual exemption, pay 28% on any capital gains is to gift items to your partner. Over their annual exemption the partner will be liable for 18% of any gains if they are a basic rate taxpayer. Once their basic rate tax band has been used up they will then switch to the higher rate.
Capital gains tax rates
Capital gains tax (CGT) was payable at one rate of 18% for all until June 2010. Since then, the actual rate that you are liable to pay has become dependent upon your income tax band. Capital gains tax is chargeable at 18% for those who are basic rate taxpayers and at 28% for any higher rate taxpayers. So for most basic rate taxpayers who only make small gains for example by selling shares, the basic rate will most likely apply.
However, things get more complicated if a substantial taxable capital gain is realised, for example, the sale of a second home. This can then push the individual over the threshold into the higher tax bracket of 40% ((32,010 in 2013-14). This is due to a quirk in the tax laws which means that income and total capital gains are added together to determine the relevant tax rate.
If a large gain is realised by a basic rate taxpayer, the total gain is added to taxable income. The percentage of the gain that falls below the higher rate tax level will be taxed at 18%, while the percentage of the gain that falls above the higher rate tax level will be taxed at 28%.
Understanding the implications
So a fundamental element when considering any investment opportunity is to fully investigate what tax could be due if you dispose of that investment. This is sometimes overlooked but can make a dramatic impact on how successful an investment is.
As illustrated capital gains tax is a complicated issue, there are different rates of taxation for different types of capital gains. What follows is a guide to some of the different sorts of investment, the tax implications that apply and what you need to take into consideration if you are dealing with future investment propositions.
Tax-free capital gains
Not all capital gains are liable for tax. The list below is by no means exhaustive but shows some of the tax-free options:
- Cash gifts between married couple or civil partners who have been registered.
- Gifts to any charities
- The selling of your main or only home.
- Private cars.
- Possessions, for example antiques and collectibles (otherwise known as chattels). For some of these items there is no chargeable tax. Possessions with a life expectancy of less than 50 years can be tax free. These are called wasting assets, as long as they are not business capital allowance eligible. Antique vases and classic cars are classed as `wasting assets`.
- Any lottery winnings or proceeds from the pools or betting.
- ISA`s, National Savings & Investments policies, child trust funds and private pensions.
- Any life insurance schemes proceeds
- Gilts, most local and corporate authority bonds, gilts and building society permanent interest-bearing shares (Pibs).
Whilst held in approved incentive schemes and in other schemes that encourage investment in growing and new businesses, shares, are not eligible for capital gains tax.
So we`ve looked at ways to invest without becoming liable for capital gains tax now we should consider the three main investment areas where capital gains tax is applicable.
1. Capital gains tax and property
Generally you will benefit from private residence relief on your main home meaning that there will be no capital gains tax to pay. However certain actions can mean that a percentage of your gain becomes taxable. For example if you are:
- Developing your home in any way such as by converting garages into flats.
- Buying or improving your home solely to make profit on the whole or part of it.
- Selling a part of your back garden and your total area is above 1.2 acres.
- Using some of your home just for business.
- Letting a part or your entire home, see the further information below.
- Living elsewhere, any gains relating to these absences can be tax-free and always include your last 3 years of owning the home.
You can nominate one home to be tax free so it is worth thinking about which one that should be. It does not necessarily have to be the one where you spend most of your time. Normally, it is advisable to go for whichever one is likely to make the greatest gain. There is a two year window in which to make the nomination for which property you would like to use. It is worth noting that civil partners and married couples are only entitled to one home whereas couples who are unmarried can choose different homes.
Letting your home?
If you have been letting a part or even your entire house when you decide to sell, a percentage of any rises in value can be argued to relate directly to the letting of that property and therefore becomes liable for tax. However if you can genuinely argue that the property has been your main home at some point you should be able to claim via the last three years of ownership rules and gain some tax relief.
There is also letting relief which can be claimed and may reduce any tax liability. This is worked out by finding the lowest amount between your private residence relief and the gain attached to the letting or 40,000.
2. Capital gains tax and possessions
As discussed some possessions escape capital gains tax. For possessions where the gain is not tax-free, there is a special way to charge for capital gains tax. The gain that is taxable is the smaller amount of either five thirds the excess of the value over 6,000 or the actual gain. Check on HMRC web site to find out further information on how to calculate this.
Being given a home
If your parents decide to leave you their home in their wills you will then inherit the property at their time of death at its current value on the market. Although no capital gains tax is liable when they die, the value of any property will be added to the overall estate making some individuals liable for inheritance tax.
If you decide not to make the property your main home but to dispose of it instead you could have to pay capital gains. Any increase in the property`s value between the death and when you sell will become a taxable gain.
Alternatively you may be given your parents` property whilst they are alive and they continue to live there, this would be a gift with reservation and the property would still be included the estate at the time of your parents death.
If and when you then did sell the property you may be liable for capital gains tax. Any amount would be based on the rise in value between when you sell it and when you were given it, even though there would possibly be inheritance tax to pay as well.
3. Capital gains tax and shares
When it comes to shares and stocks there are a number of special rules. There is no capital gains tax due on units or share held in pensions or ISA`s. To be able to work out the correct tax if you invest in identical units and shares but at different times HMRC applies a rule that assumes you sell them in a certain order.
To solve this problem, the tax rules say you must match the shares or units you are selling to the ones you bought in this order:
- Units or share bought at the same time.
- Units or share bought in the next month (30 days).
- Any other units or shares are held as one and treated as bought at an average price.
- Employee shares
Many companies now run share save schemes for employees as part of a benefits package. Depending on the type of scheme, there could be CGT to pay if you sell immediately and with all schemes there could be a future bill if you keep the shares and sell at a later date:
This is a share scheme where through monthly savings you accrue a lump sum over between three, five or seven years. Once your saving period is finished you gain a bonus that is tax free. You then have the choice to take what you have saved as cash or use the savings to buy your employer`s shares at a cost that was pre-agreed at the beginning of the plan. You may have a capital gain when you come to dispose of the shares, this is normally the net of the price at which you sell and the price at which you acquired the shares.
Share incentive plan (SIP)
Under this scheme you are given or buy the shares and they are kept in a plan for you. So whilst they are within the plan or once they have been transferred to you no CGT is due. However when the transfer occurs you will be treated as gaining those shares at their current market value. This will then be the value at which any future CGT will be calculated when you come to sell the shares. If you decide to sell straight away there should not be any tax to pay.
Enterprise management incentive (EMI)
In this incentive you will be given the opportunity to purchase company shares at a future date and price. When the option is granted if the set price is less, then any income will count towards your income tax bill. Furthermore if you invest in the option you will then become liable for a taxable loss or gain based on the net of the price at which you dispose less the price you paid less any cost paid for the option less any amount that you have already paid income tax on.
Company share option scheme (CSOP)
Under this scheme you are given the opportunity to purchase shares at a future date and price. The price cannot be lower than the current market price when the investment is granted. Again if you accept the option, you will be liable for CGT if you dispose of the shares. Normally the tax is based on the price you sell at less the price you signed in for less any costs for the actual option.
The advantages of taking out shares under the SIP or SAYE plan is that any rises in value are not liable to CGT when transferred into a personal pension or ISA within 90 days. The extra bonus is that as ISAs and personal pensions are CGT-free, there is also no CGT to pay when you do then decide to dispose of your shares.
The Bottom Line
To ensure you are making the right decision keep capital gains effects in mind when making investment decisions and not just after the fact. Pay attention to the type of investment you are making, how long you plan to hold it and its tax implications before you invest.
By being knowledgeable you can minimise tax effects and ensure that you receive even greater gains. Often it helps to seek out expert, impartial advice when you are looking at any financial matters, whether it is deciding an investment opportunity, looking for a bankruptcy advice service or searching for the right mortgage.