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:
- Bed and ISA: You can sell a fund or shares you hold outside of an ISA and then put the money you raise into your ISA. Within the ISA you can repurchase exactly the same assets if you want to. From then on it can grow without concern for the taxman, like anything else in an ISA. The 30-day rule doesn’t count with respect to these ISA purchases. The obvious snag is your annual ISA allowance is limited in size. That restricts how much bed-and-ISA-ing you can do in a particular year.
- Bed and SIPP, bed and spreadbet, and so on: You can apply the same principle of Bed and ISA to other investment vehicles that give you the same exposure but do not violate the 30-day rule. But be careful not to let ‘the tax tail wag the dog’, as they say. (For example, money put into a SIPP can’t come out until you draw your pension. Meanwhile spreadbetting to avoid CGT [5] has lots of risks for the unwary).
- Bed and spousing: Married couples and civil partners can keep an investment in the family when crystalising a gain by having one partner sell the asset, and the other party simultaneously buy it back under their own name in their own account.
- Give and take: Legally sanctified couples can also look into gifting each other assets. Such gifts are made at cost – rather than market value as would otherwise be the case. Swapping assets like this can be handy if one spouse is likely to have some capital gains tax allowance to spare or if they pay a lower tax rate. They may still face a taxable gain when selling the assets, but they could pay less tax when they do so than the other partner would. (I should confess that as a
lonely misanthropeirrepressible singleton, I’ve only ever read about [6] these arcane ceremonies).
- Bed hopping: There’s nothing to stop you selling one asset to use up your allowance and then buying something similar but different with the proceeds. You could sell your shares in big oil firm Shell, say, and then buy shares in BP. Obviously you’re now invested in a different company, but you’ll still retain exposure to an oil major. Another example would be to sell an actively managed emerging markets fund and then buy an emerging market tracker. You can even swap global tracker funds from different management houses. (The latter is a slightly grey area. Perhaps choose funds that track different global indices for a belt-and-braces approach.)
- Bed down for a month: You could sell shares that you’ve made a good gain on, and then roll the proceeds into an index tracker [7]. After 30 days you could sell some of the tracker to fund a repurchase of the original shares if they still looked good value.
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.