You might think that capital gains tax (CGT) will never apply to you. And if all your investments are in ISAs, SIPPs, or your own home, then you could well be right.

But let’s say for whatever reason you’re forced to realise a capital gain (or more likely gains, plural) big enough to take you over your CGT allowance for the year.

One simple emergency response is to consider offsetting your capital gains with capital losses where possible, to reduce the tax you’ll pay – even if it means selling shares or other assets that you had planned to keep for the long-term.

This ‘crystalising’ of losses is a very straightforward way to reduce your CGT liability, yet it’s often forgotten or misunderstood.

The key is you’re charged CGT on your total taxable gain for the year, which is:

The total gains on your profitable taxable investments1
minus applicable losses on investments that lost money2
minus any reliefs
minus your annual capital gains allowance

= Your total taxable gain

In other words, if as well as the gain (profit) you’ve made, you’re also showing losses on other taxable investments – such as shareholdings that have fallen in value – then by selling them too and offsetting those losses against your gain, you can reduce and maybe even eliminate your CGT bill.

Losses in ISAs and SIPPs don’t count: Remember, you can only offset gains using losses on taxable assets. (See my article on capital gains tax for an explanation of what counts as a ‘taxable asset’). RBS shares held in your online dealing account that are down 50% since you bought them can be set against gains if you sell them. RBS shares held inside your ISA cannot (just as they would not be liable for CGT if they rose).

At the risk of belaboring the point, the crucial thing is you must realise/crystalise your losses to use them.

It’s no good – for tax purposes – having a portfolio of clunkers sitting in the red in your dealing account that you’re waiting to come good again. Those losses don’t count until sold.

You have to dump the devalued shareholdings, take the loss on the chin (keeping a record for the taxman) and then tot up all the losses and subtract them from your gains to calculate your (now lowered) total capital gain for the year.

This isn’t rocket science, but I’ve seen people say it’s not worth it, or not understand how it works, or not think to do it – all mistakes, in my view.

If you’re going to pay a taxable gain and have potential losses to hand, then realising and offsetting those losses against that gain is free money.

Note: If you make an overall loss in a tax year, after subtracting losses from gains, then you should inform HMRC when you submit your tax return, so you can carry this loss forward to reduce gains in future years. Losses can be a valuable asset, but only if you tell HMRC!

Worked example of offsetting losses against capital gains

Here’s a made-up example to illustrate how it works.

Imagine you bought shares in Monevator PLC in 2015 for £10,000. You bought them outside of an ISA.

In 2016, a bidding war between Richard Branson and Warren Buffett breaks out for control of Monevator, and your shareholding rises tenfold to £100,000.

Having no faith in the goons running this website, you decide to sell up, take the money, and run.

Your investment has grown to £100,000, so to work out the gain you subtract the £10,000 you initially paid to buy the shares3.

The gain is therefore £90,000.

Subtracting your annual CGT allowance4 from that gain (and assuming you’ve not realised any other gains in the tax year) means you’ve made a taxable gain of:

£90,000 minus £11,100 = £78,900

A hefty tax bill will clearly be due on that £78,900. If it were all charged at the higher CGT rate on shares of 20%, then you’d pay £15,780 in tax.

But wait!

While sitting in a pool of your tears as you lament the demise of your favourite investing blog AND your imminent tax bill, you remember some shares in other companies that you continue to hold that didn’t do so well.

In fact, your dealing account shows you’re currently down £20,000 on your investment in Sky, and you’re also £35,000 underwater on the Daily Mail and General Trust.

You had planned to hold on for a recovery in their prices. But given the imminent tax bill, these shareholdings are probably worth more to you dead than alive.

If you’re paying the higher-rate 20% of CGT, then realising these losses and offsetting them against your CGT gain will ‘earn’ you £200 for every £1,000 of loss.

Note that nobody is suggesting that you make a loss just to reduce your tax bill (well, some US Republican diehards might, but I’m not).

In this example you’ve already made the unprofitable investments. The damage is there already in the losses on your shareholdings. By selling up and offsetting those losses against your taxable gain, you’re reducing the impact on your total wealth.

What’s more, you can reinvest the money you raised from selling your losers, too.

This means there’s a potential double-whammy at work of using the losses to offset your gain, and then seeing your reinvested money rise in value in the future.

Beware the 30-day rule! Note that you can’t repurchase the same company’s shares within 30 days of you selling them and recognising the loss, according to HMRC’s bed and breakfasting rules. If you do repurchase the same assets within 30 days, the loss does not count as crystalised and so cannot be set against your gains.

The 30-day rule means you’d have to wait a month to repurchase exactly the same shares or fund that you sold for a loss to offset that loss against gains. Not likely to be a disaster, but there’s a danger that the market could move against you.

On the other hand the shares or fund might get even cheaper! A month is a pretty short and random time in the markets.

However there’s also nothing to stop you investing the money raised in another share or fund you fancy – perhaps a share from the same sector or even a close competitor – or putting it into a similar but different ETF or fund.

Many active investing Monevator readers will have plenty of ideas for where they’d like to deploy new money, so this influx of cash could be a silver lining to realising losses. Cutting losers and running winners can be a good discipline when active investing, depending on your strategy.

Remember your overall asset allocation though. If you’re a passive investor in broad asset classes, you should ideally be selling winners and adding to losers when you rebalance your portfolio. Tax mitigating operations should only be a side detour in your plan, not a change of direction.

Also note that you can buy back assets you sold for a loss inside an ISA or SIPP without violating the 30-day rule. This is known as bed-and-ISA-ing (for historical reasons). See my article on defusing capital gains tax for more details.

How capital losses reduce your tax bill

Getting back to my example, you’ll recall we were faced with a taxable gain of £78,900.

By selling those two hefty losers and offsetting the losses realised against our gain, the total taxable gain is reduced to:

£90,000 minus £35,000 minus £20,000 minus £11,100 = £23,900.

Let’s say you still fall into the 20% CGT bracket, even on this lower gain.

On £23,900, that works out as £4,780 tax due.

A poke in the eye, but only about a third the size of the bill you originally faced.

Other times using losses will be enough to take you back under the annual CGT allowance, or else may bring you down to the 10% rate if you’re a basic rate payer. So there are potentially lots of advantages here.

Obviously these are just made up numbers, based on a made up example that’s overly simplistic for illustration.

But the takeaway is clear. If you face a capital gains tax bill and at the same time you have unsheltered shareholdings that are showing a big loss, there’s a strong case for selling them to realise the losses to offset them against the gain, even given the hassle and churn costs.

Of course, keep all your passive investments nicely wrapped inside ISAs and SIPPs and you won’t have to worry about offsetting capital gains or defusing them or any other fiddling about.

For the gazillionth time – if you’re investing and not using your annual ISA allowance, then you are making work for yourself, and potentially setting yourself up for hefty capital gains tax bills, too.

1. Remember, investments only become liable for CGT when they are sold or transferred. [↩]
2. Similarly, capital gains losses are only crystalised when you sell them. [↩]
3. I am ignoring dealing fees and other costs here for simplicity. Such costs are also deducted from your sale proceeds when calculating the taxable gain. [↩]
4. £11,100, rising to £11,300 from 6 April 2017 [↩]

The recent fee bomb dropped by Interactive Investor has caused many Monevator readers to think about a swift ISA transfer to other investment platforms. We presented our alternative picks here but what about the stocks and shares ISA transfer process itself? How tricky is it?

Well, there are a few things to think about, and because a fair wedge of Monevator readers are monogamous passive investors who don’t break up relationships unless they really have to, let’s do a quick guide to dumping your ISA provider.

Dear ISA provider… it’s not me, it’s you

The first thing to note is that a stocks and shares ISA can only be transferred to another stocks and shares ISA. That makes it slightly less flexible than a cash ISA, which can be emptied into a stocks and shares ISA if you fancy it.

That established, you have three options for extracting your ISA from the clammy hands of the unworthy:

1. Cash transfer

Your current platform sells your assets and transfers the cash directly to your new ISA provider. You choose new investments from scratch, making this option good for a brand new start, if things have got a little, ah, messy.

• Your ISA’s anti-tax armour remains unbreached.

• It should take about two weeks to transfer, but it could take up to six.

• You are out of the markets as soon as your assets are sold and until you repurchase a fresh batch. That could go for or against you. No one knows.

2. Stock transfer

The existing contents of your ISA are transferred intact to your new provider. In other words, all your funds and shares are handed over without being sold or repurchased. This type of ISA transfer is often referred to as an in specie transfer, or as re-registration.

• Again, your ISA’s tax status is not compromised.

• It should take about four to six weeks but it often takes several weeks longer.

• You remain in Mr Market at all times and are subject to his whims.

• You won’t be able to trade until the transfer is complete.

3. DIY sell-off

Of course, you can always flog your assets yourself and use the proceeds to open up a new account with another ISA provider.

• Your ISA’s tax powers are very much kyboshed in this scenario.1

• Transfer out fees are avoided, though perhaps not account closure charges. Also note some platforms will pay your transfer fees to secure your business.

• You’ll pay dealing fees to sell and buy anew.

• You’ll be out of the market for a few days.

Stock transfer: The nitty-gritty

Personally, I would use a stock transfer all day long. The annual advance of a market can occur in just a few days and I’d hate myself if I missed out.

However, there are a couple of potential snag-ettes to watch out for with the ol’ in specie manoeuvre:

• Contact your new provider and old provider to make sure they both play ball when it comes to in specie transfers.

• Check that assets in your old ISA are available in your new one. If not, then talk to your new provider. Otherwise, incompatible assets are likely to be sold.

• Different provider’s forms use different terminology to describe an in specie transfer. Check if you’re not sure which box to tick, and, whatever you do, avoid the box marked ‘liquidate’.

• Your old provider is likely to impose a transfer out charge – just one last pound of flesh before you leave. This is typically £15 – £25 per fund or stock. Some new providers will pay these fees for you. (Occasionally, as with Interactive Investor currently, they might be waived. It never hurts to ask!)

To do list

If your old provider’s ‘just one last chance’ pleas have fallen on deaf ears and you’ve identified your new dream partner then completing your stocks and shares ISA transfer isn’t much more daunting than filling in a form:

• Complete the ISA transfer forms provided by your new platform.

• Ask your new provider if it will cover your transfer out fees.

• Tell your old provider to close your account once the transfer is complete. You don’t want them pursuing you for inactivity charges.

• Cancel your old direct debit and relax.

That’s about all you need to know. I’ve got a couple of bullet points left in the tips-gun though so let’s fire ’em off:

• Your new platform should tell you when your account has transferred.

• You can transfer your current year’s ISA, although new money can only be added when the transfer is complete.

• ISA transfers do not count towards your current year’s allowance.

• You can transfer some or all of your previous years’ ISAs.

• You can even partially transfer an ISA. List the assets you’d like to transfer, though note that your old provider can refuse a partial transfer. You can’t partially transfer your current year’s ISA.

• Document all your holdings (names, ISIN codes, quantities held) before you transfer. Take a screenshot of your holdings sitting in your old broker. This will come in very handy should any holdings go astray during the transfer.

That’s it. We’re done. Happy transferring.

Take it steady,

The Accumulator

1. In other more boring words, the money you had tucked away in the ISA loses its tax protection. [↩]

Good reads from around the web.

I am soon going to sell shares in a private company I co-founded a few years ago and later left. The company has been pretty successful, not least because of the drive and talent of the people at the top, who remain good friends.

I believe selling now makes sense for all concerned, but I do so with a few qualms. Unfortunately, one of those is that it will trigger a capital gains tax event.

The sale of my shareholding will generate a significant five-figure gain, far beyond the £10,600 annual CGT allowance. Despite having a 5% or greater shareholding, it seems I don’t qualify for entrepreneur’s relief as I haven’t been employed by the company within the last 12 months. This means I’m potentially on the hook for 18% at the basic rate of capital gains tax, or 28% if I breach the higher rate bracket.

Tax avoidance is perfectly legal, and needless to say I’m engaged in reducing my CGT liability. For example, the market volatility since April has been kindly timed for me – whereas before April I was defusing capital gains on various shareholdings, now I’m carefully selling losers to offset the far bigger gain that’s coming due. (More on this next week).

I’ll probably also reinvest more into my current business this year, rather than draw too much income out of it only for that to inflate my tax bill.

Taxing matters

Despite my disquiet about excessive public spending, I’m not a survivalist nutter who believes the state should confine itself to pointing nukes at the Ruskies.

Everyone ought to pay their share of taxes, and I do.

I’m also aware that private equity firms and the like exploit the rules on capital gains tax to pay lower rates than their secretaries, despite often engaging more in City chinwags and financial chicanery than in real entrepreneurship.

But I have to say I am pretty miffed about the tax treatment of a private individual’s modest capital gains, whether on a company they started or on shares and the like.

The £10,600 allowance might seem a lot when you start investing, but once you’re into six figures (and you’ll need to be, eventually) it’s a joke. I’ve noticed that older investors are much keener on ISA-ing and SIPP-ing their stocks and shares than new investors are, and I’m sure this is why. Even I didn’t use tax-exempt wrappers until 2003, and I regularly regret it.

When I co-founded that business back in 2005, I put about one-fifth of my entire worldly wealth into it. More importantly, I gave up most of my other work, which slashed my income by more than 80%. We didn’t pay ourselves at all for a year, despite a six day week of 10-12 hours a day. When a salary did come, it began at less than I earned in my first (poorly-paid!) job out of university.

We took all the risk. We didn’t take a penny of State money, grants, or anything like it. Yet the State wants a share.

Fair enough, there is entrepreneur’s relief in some circumstances, but it doesn’t fit mine and I don’t particularly see why my own risk-taking should be penalised on technicalities.

And what about capital gains tax on everyday share investing?

Again, I am sympathetic to income redistribution, especially in this age of spiraling inequality. The rich will always get richer, and that’s ultimately unsustainable. Personally I’d do more redressing through inheritance tax, though I seem to be in a tiny crowd on that score.

In any event, taxing a small investor who gets a break is hardly going to curb the rise of the 1%, or prevent capitalism eating itself as Marx predicted.

It also does nothing to encourage a culture of saving and prudent investment. Rather, it encourages people to follow the herd into the next property bubble, given that capital gains made on your own home are entirely tax-free.

I have on my shelf a copy of Investment Made Easy, by Jim Slater. It was the first book on investment I ever bought, and it was published in 1995. Slater cites the capital gains tax allowance as £6,000.

That means the CGT allowance has gone up 77% in the 17 years since then. Sounds good, but let’s compare it to the CGT-free status for housing.

According to the Nationwide, the average UK house cost around £51,000 when 1995 began. After peaking in late 2007 at £184,000, the average price is now down to around £162,000. That’s still a gain of 217%, which means the CGT tax-free perk on housing has in money terms become much more valuable over time, compared to the CGT allowance.

Of course, CGT isn’t payable on homes at least partly because the government doesn’t want to slow down the market – and hence mobility, employment, and the like – by putting people off selling up.

But I’d still question whether our priorities are entirely in order here. At the least, an annual CGT tax-free allowance on other gains of say £20-30,000 seems appropriate.

In my case, the lack of ISA sheltering and the winners-and-losers nature of stockpicking means I’m not too badly off. I’ll be able to offset most of the gains, albeit at the cost of turnover and associated fees that would make The Accumulator dizzy. Ironically, my tardiness in sheltering shares over a decade ago is going to save me thousands of pounds.

But I think this is an unusual set of circumstances, and they probably won’t be able to help me next time I sell a business or similar. (I’m not that bad a stockpicker, and I’m not that rich!)

[continue reading…]