how to reduce your bill

With capital gains tax at an all-time high, Alice Guy looks at how tax works and ways to lower your bill.

2020-21 has been a banner year for the IRS. Capital Gains Tax (CGT) raised £14bn in total, 42% more than the previous year. And more taxpayers footed the bill, with 323,000 paying CGT in 2020-21, an increase of 53,000 from 2019-20.

Alex Davies, managing director of Wealth Club, said that “this is a large increase over the amount received the previous year, which is attributed to media speculation about CGT rule changes, changes in policy affecting eligibility for certain reliefs, and also to a lesser extent, an increase in the number of rental assignments due to the change in tax rules”.

How does capital gains tax work?

Capital gains tax is levied on the profit from the sale of shares, investments, second homes and businesses. Each tax year, taxpayers receive an annual CGT allowance of £12,300, after which CGT is due. If you do not use your allowance, it cannot be carried over to the following year.

For example, if you bought a rental property in 1990 for £100,000 and sold it in 2022 for £450,000, your initial capital gain would be £350,000. Say you spent £50,000 improving the property by building an extension and £20,000 in legal, estate agent and other fees when you bought and sold the property. Your total capital gain would be £280,000 and your taxable gain would be £267,700 (£280,000 less £12,300 annual exemption). Assuming you are a higher rate taxpayer, the tax due would be £74,956 (28% of £267,700).

Capital gains tax traps

Complicated rules mean it is possible to unwittingly get caught in the net of capital gains tax.

For example, owners normally benefit from an exemption from CGT for their main residence, but they can lose out if they move and keep their old accommodation for more than 18 months. This means that if you moved and haven’t sold your house for two years, you could have a CGT charge for the additional six months.

Taxpayers also sometimes forget that giving away property is tantamount to selling it for the taxman. This means that if you offer a rental property to your child, you will have a CGT bill to pay on the difference between your selling price (HMRC uses the market rate if you offer a property or sell it for less than the value merchant) and purchase the price.

How to Minimize Capital Gains Tax

The good news is that there are still several steps you can take to lower your tax bill. Here are some possible ideas:

  • Use your ISA allowance: You can invest up to £20,000 in an ISA each year, or £40,000 as a couple, and any gains will be exempt from CGT and income tax.
  • Bed and ISA: This is when you sell assets and buy them back into an ISA. You can either make a gain or try to keep your gain as part of the annual allowance. Be careful, because even a short period out of the market can reduce your long-term wealth if the value of the asset increases.
  • Use your pension: You can invest up to £40,000 per tax year into your pension, or £4,000 if you have started to receive pension income. Again, any gain is exempt from CGT and income tax.
  • Transferring assets to a low-income spouse: Transferring or sharing ownership of assets with your spouse allows you both to use your annual allowance when you come to sell. You can also save on tax if they are a base rate taxpayer, as they will pay CGT at a lower rate.
  • Use your losses: CGT losses from previous tax years can be offset against the gains, if you report the losses to HMRC within four years of the end of the tax year in which you sold the assets.

Other tax saving schemes

To encourage investment, there are also a series of devices – some risky – that investors could consider.

Alex Davies comments that “Pensions and ISAs are great, but allowances can be restrictive for some. To mitigate this, if you are willing to take on additional risk, you can turn to government venture capital programs. Each offers a different combination of tax benefits. What you choose will largely depend on the circumstances and the level of risk you are willing to take. Generally, the greater the tax benefits, the greater the risk.

“Venture Capital Trusts (VCTs) offer up to 30% tax relief. Returns are paid through regular tax-free dividends, which is a nice bonus, and all winnings are CGT-free. The allowance is a very respectable £200,000 a year.

“Investments under the Business Investment Scheme (EIS) also offer up to 30% relief from income tax. There are no tax-free dividends, but an advantage here is that you can also defer capital gains.As long as you remain invested in any EIS, you can forget about the CGT bill.It will only become payable once you exit the EIS, unless you reinvest the money in another.The EIS allowance is £1m per year or £2m if you invest at least £1m in ‘knowledge-intensive’ businesses .

“The Plant Business Investment Scheme (SEIS) is the most generous when it comes to tax savings. When you invest, you can get up to 50% income tax relief and 50% capital gains tax relief for reinvestment. The allowance is more modest but still significant at £100,000. Still, this means that a £100,000 investment could save you up to £50,000 in income tax plus £14,000 in capital gains tax (assuming you paid 28% of CGT on the sale of a property).

If you are considering investing in any of these programs, it is advisable to seek financial advice. The rules are complicated and whether the diets are right for you will depend on your situation.

These articles are provided for informational purposes only. Sometimes advice on whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt an investment strategy, as it is not provided on the basis of an assessment of your investment knowledge and experience, your financial situation or your investment objectives. The value of your investments and the income from them can go down as well as up. You may not get back all the money you invest. The investments mentioned in this article may not be suitable for all investors and, if in doubt, an investor should seek advice from a qualified investment adviser.

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