As everyone knows, HMRC takes a slice of your income in the form of income tax, but the taxman is also interested in any profits you make by buying and selling assets – houses (apart from your home), cars, paintings, stocks and shares. So if you’re selling, swapping, gifting or otherwise transferring an asset, you’re going to need to think about capital gains tax (CGT), which is a tax on the “gain” you made while you owned it.
When do you have to pay CGT?
Sometimes, a liability for CGT is obvious: if you’ve bought a painting for £10 in a car boot sale and it turns out to be a Rembrandt that you sell for £1 million, you’re going to be paying some CGT. Ditto that student house you did up and sold on at a profit, the technology stock that went up 100x or the sale of your vintage edition Casino Royale.
However, CGT can seem sneaky. It can also fall due when there’s no money exchanged at all – if you transfer an asset to a friend, swap houses with a sibling or gift a vintage watch. It can occur wherever there is a change in ownership of an asset.
This sounds daunting, but there are plenty of exemptions and offsets. You can transfer anything you like to your spouse, for example; while your main home, your car and anything held in an individual savings account (ISA) or pension are exempt.
How much is it?
Compared with income tax, CGT is low, but it will vary depending on your tax status and the type of assets you’re selling or transferring.
Everyone has an annual allowance. This is £12,300 for the 2021/2022 tax year. This is deducted from any gain and tax is only payable above this amount. So if you bought an asset for £150,000, and sold it for £162,000, you’re in the clear.
If you pay higher or additional rate income tax, any gain over the annual allowance is levied at:
- 8% on your gains from residential property
- 20% on your gains from other chargeable assets
If you’re a basic rate tax payer, it’s a bit more complicated. The rate you pay depends on the size of your gain and the extent to which your allowances have already been used up elsewhere.
There are useful calculators online, but HMRC distils the calculation into five main steps:
- Work out your taxable income.
- Work out your gain.
- Deduct the tax-free allowance (currently £12,300) from your total gain.
- Add this amount to your taxable income.
- If this is within the basic income tax band (£12,570-£50,270 income, although different rates apply in Scotland), you’ll pay 10% on your gains – or 18% for residential property. On any amount over this, you’ll pay 20% or 28%.
Example of CGT in practice:
Your taxable income (your income minus your personal allowance and any income tax reliefs) is £20,000. You sell shares that you inherited from your aunt for £35,000. When you inherited them, they were worth just £14,000. So you have a total gain of £21,000.
In calculating how much you owe, you first need to deduct the tax-free allowance from your gain. £21,000 less £12,300 leaves you with £8,700 on which you’ll need to pay tax.
You need to add this to your taxable income, which leaves you with £28,700. This doesn’t push you into the higher rate tax bracket because it all falls within the basic rate band (£37,500 for 20/21). So you’ll pay 10% on the whole gain, leaving you with a bill of £870.
Your main home
Your main home is exempt under the “principal private residence” (PPR) rules. If you have two homes, you can make an “election” to have one treated as your main home (an “election” is just an HMRC form ). HMRC is unlikely to accept that a holiday home in which you spend a couple of weeks a year is your main residence. Married couples and civil partners can only count one property as their main home at any one time.
If you’re selling a rental property, there are various exemptions. You’ll get full relief for the years you lived in the home (ie. the time it was your PPR), plus the last 9 months you owned the home, even if you weren’t living there at the time (this used to be 18 months, but changed at the end of the 2020 tax year).
You can also deduct various expenses. These include the costs of buying, selling or improving your property. In general, this covers:
- Estate agents’ and solicitors’ fees
- The costs of improvement – including an extension, new bathroom, kitchen or windows. NB: Normal maintenance costs, such as painting or repairs, don’t count.
HMRC has a calculator to help you work out your gain:
When is the tax due?
Until 2020, anyone who had made a capital gain on their property had a relatively relaxed 22 months to pay their CGT bill. Today, you’ve got just one month from sale or disposal of the property. You will have to submit a residential property return and make a payment on account within 30 days, so you need to be organised when selling a buy to let property or holiday home.
For all other assets, you have longer to make your tax payment: you need to report it by 31 December in the tax year after you made the gain. So if you sold shares in February 2021, you’d need to report it by 31 December, 2021. Once you’ve reported it, you should receive a letter or email from HMRC giving you a payment reference number and telling you how to pay.
There are various assets that are exempt from CGT. In general, you can give as much as you like to your husband, wife, civil partner or a charity without occurring capital gains. This can be a useful tax-planning device, as we’ll explain later. You also won’t have to pay CGT on:
- Assets held within an ISA or pension fund
- UK government gilts and Premium Bonds
- Betting, lottery or pools winnings
- Private motor cars, including vintage cars
- Personal belongings (or ‘chattels’) where the sale proceeds are less than £6,000.
- Foreign currency held for your own use.
Saving capital gains tax
CGT rates are currently low relative to history, but at a time of straightened government finances, there are persistent rumours that rates will move higher. There are ways to keep your CGT bills to a minimum.
- Use your exemptions. The £12,300 allowance operates on a ‘use it or lose it’ basis. As such, it’s worth using each year where possible. That may mean strategically selling assets to use the allowance each tax year. This won’t be possible with large assets such as property, but can be an option for shares or other assets.
- Equalise your assets. You and your spouse are each entitled to the £12,300 allowance. If the bulk of the household assets are in one person’s name, it is worth taking advantage of the ability to transfer between spouses tax free to ensure you use both exemptions.
- Create an artificial transfer. This is complex and generally best left to the professionals, but you may be able to bank a lower rate of CGT by creating a chargeable event. That means selling to a trust, transferring to a child or other third party.
- Use any losses. If you’ve made a loss on an asset, you can set this against any CGT liability for the year. You may be able to use this strategically, selling assets in the same year as you’ve made gains elsewhere.
- Consider enterprise investment schemes (EIS). These are high risk investments and need to be used with caution. Nevertheless, they can be a tool to defer gains rather than avoid them. This can be useful if you expect to pay a lower rate of tax in future (such as on retirement). There are other tax breaks available on EIS investment.
- Use your ISA and pension allowances each year. There is no CGT on assets held in a pension, Isa or investment bond. You can put £20,000 in an ISA each year and up to £40,000 in a pension (rates for the 2021/2022 tax year). You can also sell assets and then buy them back in a tax-exempt wrapper.
- Consider your principal private residence election (choice). Not many people will have a choice of houses, but where it happens, it is worth looking at which property has seen greater gains.
CGT can catch you unawares and if you have a large gain, it can be worth talking to a professional adviser about your options.
All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.