- Monevator - https://monevator.com -

Alternatives to bed and breakfasting to reduce CGT

A question from a reader about ‘bed and breakfasting’ – and she’s not talking about English muffins versus the continental options:

Dear Monevator,

I have an old investing book/bible that tells me I should be bed & breakfasting my shares to reduce taxes. Is this possible in the era of Airbnb? (Just joking!) Seriously what is bed and breakfasting shares? Is it still even legal as I don’t think you’ve written about it?

Yours,

A. Reader

Dear reader! So-called bed and breakfasting was a now-defunct method to help you reduce capital gains tax on shares [1] (CGT).

In the olden days – when mitigating taxes [2] was mostly a sport for retired stockbrokers in the Home Counties – you would sell a fund or tranche of shares you owned one day to realise a capital gain – ideally for less than your annual CGT allowance – and then buy back the same fund or shares the next day.

Doing so reset your cost base. Which, in turn, defused the future capital gains tax liability you were building up when your fund or shares rose in value.

What a wheeze!

People typically did their bed and breakfasting at the end of the tax year. They’d sell on the last day of the tax year and then buy back the next day.

Bed and breakfasting enabled you to make use of your annual CGT allowance [3] without losing exposure to an investment that you presumably wanted to keep. (Since you only sold it to defuse the CGT).

No more bed and breakfasting CGT

Bed and breakfasting was a simple operation. But it cunningly helped prevent moderately-sized gains from becoming liable for tax by defusing [1] a portion of the gains each year.

Alas the whole scheme long ago went the way of paying urchins to sweep your chimney. Bed and breakfasting was crippled by tighter rules about when you can repurchase the same asset if the disposal is to count as a taxable sale.

In short: nowadays you can’t just sell and buy back the next day to defuse CGT.

Instead you must leave a 30-day period between buying and selling the same assets. Any less and you haven’t crystalised the CGT gain from HMRC’s perspective.

Thirty days! That’s not so much bed and breakfasting as bed and hibernating!

During those four and a bit weeks, of course, the value of your investment will fluctuate. So you could miss out on gains. (Or losses…)

What’s more, the CGT allowance has been cut and cut again in recent years. This means there’s much less headroom for defusing gains anyway.

On the other hand, we do enjoy a generous £20,000 annual ISA allowance [4].

And ISAs are entirely impervious to tax, which means that over the years you can build up a chunky tax shelter to hold your assets inside and never worry about CGT anyway.

Alternatives to bed and breakfasting to reduce CGT liabilities

If you do still hold assets in general investment accounts – i.e. outside of ISAs and pensions – then there are other options to bed and breakfasting, which exploit the same general idea of using up your CGT allowance to defuse gains.

They are not perfect swaps, but you could:

Keep records of all these trades in case you need to report them to HMRC.

Worth doing, but better avoided

There’s a cost to churning your portfolio like this, and it’s not just heartburn.

Share dealing fees may be low – or even zero [8] – these days. But stamp duty of 0.5% on most share purchases will make a dent into your capital. There are bid/offer spreads, too.

What’s more, if you plan on doing a return trip after 30 days then that’s going to double your costs again. (You could just sit in cash. But then you risk the market moving against you.)

Again, it’s always best to invest in an ISA or pension [9] where possible. This keeps your investments shielded from CGT entirely. Start young and you can build up a substantial ISA portfolio, while annual pension contributions can currently be up to £60,000, if you earn enough. Though who knows how long before the politicians meddle with pensions again.

Some people do still have big portfolios outside of tax shelters. Maybe they’re rich, or they’re obsessed [10] with investing. Or perhaps a lump sum like an inheritance overwhelmed their limited annual allowances.

If that’s you, then the methods I’ve talked about above are worth doing to prevent taxes eating up [11] your returns in the future.