Until they start taxing sex, capital gains tax (CGT) is probably the most annoying tax to find yourself paying.
Capital gains tax is a tax levied on the profits you make when you sell or transfer assets like shares, rental properties, or even a stake in your own company.
Like a fly in your soup on your birthday, paying capital gains tax can really spoil the fun of making money.
Unlike inheritance tax, which is a tax on your good fortune, or income tax, which is a cost of having a job, capital gains tax is a tax on investing success.
Take shelter from CGT! Always try to use tax shelters like ISAs and pensions to shield your investments from capital gains tax where possible. No CGT is payable on gains realised within these wrappers.
Of course, you won’t always make a profit when you sell an investment.
Sometimes you will lose money – that’s called a capital gains loss, and unfortunately you don’t get money back from the government for losing money.
However, you can offset capital losses against your capital gains to reduce the total gain you will pay tax on.
How UK capital gains tax works
Like income tax, capital gains tax is calculated on the basis of the tax year, which runs from 6 April to 5 April the following year.
CGT is paid on the total taxable gains you make selling assets in that tax year, after taking into account:
- Your annual capital gains tax allowance. (See below).
- Other reliefs or costs that can reduce or defer the gains.
- Allowable losses you made by selling assets that would normally be liable for CGT. (The opposite of a capital gain, in other words).
Everyone has an annual capital gains tax allowance, or ‘annual exempt amount’ in HMRC-speak. This allowance is £11,300 as of 6 April 2017.
If your total taxable gains, minus any deductions, comes to more than your annual allowance, then you pay capital gains tax on everything over that tax-free allowance.
Capital gains tax rates
There are several different rates for capital gains tax. The rate you’ll pay normally depends on your total taxable income, and what sort of assets you’ve made a profit on. Second homes and buy-to-let properties are taxed at different rates from other assets.
For most taxable assets:
- Basic rate taxpayers pay 10% on their capital gains.
- Higher rate taxpayers pay 20%.
For second homes and buy-to-let properties1:
- You’re charged 18% at the basic rate on your property gains.
- Higher rate taxpayers will pay 28%.
Your main home is nearly always exempt from capital gains tax under what’s called Private Residence Relief. This is automatically applied unless you’ve let your home out to more than a single lodger, used it for business, or if you’ve substantial acreage. In those cases, CGT might be payable.
Note that you might normally be a basic rate taxpayer, but have to pay a higher rate on your capital gains if the money you’ve made is enough to move you into the higher rate bracket.
To work out what rate you’ll pay, your capital gain is added to your taxable income from other sources (salary, dividends, savings interest, and so on).
This can all get a bit complicated – see HMRC’s notes on working out your capital gains tax rate band.
What is CGT charged on?
The good news is in the UK capital gains tax is a fairly avoidable tax for most investors.
(Remember, you’re allowed to avoid paying taxes where possible, but tax evasion is illegal.)
Most capital gains on asset sales are taxable, but in the UK capital gains tax is NOT charged on these assets:
- Your main home (in 99% of cases)
- UK Government bonds (gilts)
- ISA and SIPP holdings
- Personal belongings worth less than £6,000 when you sell them
- Your car, unless used for business
- Other possessions with a limited lifespan
- Betting, lottery or pools winnings (including spreadbets)
- Money which forms part of your income for Income Tax purposes
- Venture Capital Trusts
- Certain business holdings that qualify for entrepreneur’s relief.
That still leaves many key assets liable for UK capital gains tax when held outside of an tax shelters, including:
Don’t forget, as I’ve already mentioned you also have that annual capital gains tax allowance.
So you won’t necessarily be liable for CGT just because you’ve sold some taxable assets and made a profit. It all depends on your total capital gains for the year.
When to report CGT: You need to report your taxable gains via your self-assessment tax return if your total taxable gain in the tax year exceeds your CGT allowance OR if your sales of taxable assets are in excess of four times the allowance. So if you sold £20,000 worth of shares in the year2 for a total gain of £5,000, there’s no need to report any of it. (Your total sales were less than four times the annual allowance, and £5,000 in gains is below the annual allowance). If you’d sold say £50,000 of shares, you would have to report the details, regardless of the total gain.
Capital gains are pooled together
All capital gains and losses go into the same ‘pot’ from the Inland Revenue’s point of view.
For example, if you made a gain of £15,000 selling shares and £8,000 selling an antique wardrobe, your total capital gain would be £23,000.
Here losses can help you out. For example, if you make a taxable gain on your shares but a loss on selling your buy-to-let property, then that loss can be offset against the capital gains to reduce or even wipe out the CGT that might otherwise be due.
See my article on avoiding capital gains tax for eight other ways to reduce or avoid a capital gains tax bill.