Five strategies to reduce your CGT liability
As we near the end of the tax year on 5 April 2012, readers should review their capital gains tax positions to see if they can reduce their tax bill or minimise future bills.
CGT is normally charged at either 18% or 28% on gains above a tax-exempted amount, which this year is £10,600. The tax rate depends on your income tax position. If your income falls into the basic-rate tax band (£35,000 or less), CGT is charged at 18%. If your income is above this threshold, the CGT rate is 28%.
Don't forget to take into account the personal allowance, which is £7,475. Thus, if your income is below £42,475, CGT is charged at 18% until the gains use up the rest of your basic-rate tax band. Thereafter CGT is charged at 28%.
Let's say Diane has a salary of £30,000 and has made gains in the year of £25,000. After deducting the annual exemption of £10,600, she has a taxable gain of £14,400.
Her income is set against her personal allowance so her taxable income is £22,525. As the basic-rate tax band is £35,000, £12,475 of her gain is taxed at 18%. The remaining £1,925 is taxed at the higher rate of 28%, bringing her total CGT tax bill to £2,785.
1. Shelter gains by taking losses
Many investors will have seen a painful drop in the value of their assets over the past year. This has no immediate tax consequences unless they sell assets. However, selling assets can help them shelter some capital gains by crystallising a loss. If you have made gains in the earlier part of the tax year that exceed your annual exemption, selling some assets at a loss before the end of the tax year on 5 April could reduce or wipe out your CGT bill.
Dave, a higher-rate taxpayer, sold a buy-to-let property last July and made a gain of £50,000. After deducting his annual exemption of £10,600, he has a taxable gain of £39,400. CGT is charged at a rate of 28%, so the tax bill for the year would be £11,032.
However, if he is sitting on assets that, if sold, would realise a loss of £20,000, he could offset this loss against his gains in the year. This would bring his taxable gains down to £19,400, which would reduce his CGT bill (at the 28% rate) to £5,432, a saving of £5,600.
Realising losses of more than £39,400 would be a waste. The gains that would be shielded from CGT are already protected by his annual exemption.
Where losses exceed gains in a year, the losses can be carried forward and set against gains in future years, but only if these gains exceed the annual exemption. The losses should not be wasted on future gains that are covered by the annual exemption.
2. Consider bed and breakfast
If you are sitting on asset gains, you may wish to 'bed and breakfast' your asset to make use of your annual CGT exemption. The idea is to sell now, make a capital gain that is absorbed by the annual exemption and repurchase at the current, higher, cost. There is no tax to pay now and future gains should be lower, as you will have lifted the base cost that will be used to calculate future gains.
To discourage this, the government has changed the rules so that you now have to wait 30 days before making the repur-chase, otherwise the sale and repurchase are ignored for tax purposes and the shares are treated as if you hadn't sold and repurchased them. You face the risk that the share price will move against you in that 30-day gap.
One way around this is to sell while your spouse or civil partner makes an identical purchase on the same day, a tactic called bed and spouse. This may have the added advantage of transferring income generating assets to a spouse with a lower marginal tax rate.
Another option is to bed and ISA, by re-purchasing the shares within an ISA, so that higher-rate tax is avoided on future dividend income and future gains are exempt from CGT altogether.
3. Transfer assets between spouses and civil partners
An alternative way of making use of a loss is for an asset to be transferred between spouses or civil partners. This can be worthwhile if, say, a man has gains but his wife is holding an asset that has lost value. If she transfers the asset to her husband and he sells it, the loss it his, so he can reduce his net gain and his CGT liability.
Transfers between spouses and civil partnership couples take place at 'no gain, no loss', providing a useful technique for minimising a family's CGT liability. The tactic also works the other way around. A man has a loss and his wife has an asset that has risen in value. She transfers the asset to him. He sells it and sets his loss against the CGT he must pay on the gain from the sale.
Assets can also be transferred between a couple so that income is taxed in the hands of the partner who bears tax at a lower rate.
4. Beware ISAs and capital losses
One perhaps unforeseen aspect of the ISA regime is that, while gains are exempt from CGT, losses are not allowable. Con-sidering that the CGT exemption is for most people the main reason for investing in an ISA, given recent stock market performance, they may wonder why they bother.
If you hold a lot of bank stocks in an ISA, you may have suffered large capital losses, but these cannot be offset against gains outside the ISA or on the disposal of other assets.
5. Exploit entrepreneurs' relief
Entrepreneurs pay a lower CGT rate of 10% on gains, up to a lifetime limit of £10 million.
However, in determining the rate at which CGT is charged on any gains not qualifying for entrepreneurs' relief, the gains qualifying for entrepreneurs' relief are set against any unused basic-rate band before non-qualifying gains.
Suppose Stella, a serial entrepreneur, makes a gain of £8 million on the disposal of a business in the current year. She has previously made gains qualifying for entrepreneurs' relief of £4 million. Her income after deducting her personal allowance is £25,000.
As she has previously made gains of £4 million, only £6 million of the disposal this year qualifies for the entrepreneurs' rate of 10%. The other £2 million is taxed at the normal CGT rate of either 18% or 28%.
However, the £6 million of the gain taxed at 10% is given priority over other gains that don't qualify for entrepreneurs' relief in determining whether total income and gains exceed the basic-rate tax threshold. As a result, none of the basic-rate band remains, so the remaining £2 million gain is taxed at 28% (after deducting the annual exemption).
Share asset ownership to minimise CGT
One way to make use of annual exemptions involves grouping together to own assets. Instead of four people each owning an asset of equal value, they could own four assets collectively. Assuming all assets have increased in value and a considerable amount of CGT is payable, the group could sell one of the four properties each year.
Each individual would set their annual exemption against his or her share of the gain, thereby using all four annual exemptions against each gain. If each asset is held individually, each gain is only offset by one annual exemption.
Imagine two couples - Bob and Carol, and Ted and Alice - bought four properties as equal partners. The gain on each property is £50,000 and they sell one property per year. Assuming the annual exemption remains at £10,600 for each of the relevant years of the disposal and they are higher-rate taxpayers, the CGT on the four disposals would be £2,128.
If, instead, they each hold one of the properties and sell them individually, the CGT would be £11,032. By owning assets jointly, they have saved themselves £8,904 in tax.
Any number of individuals could group together to do this. However, the approach might only be practical for small groups, such as two couples who want to hold rental properties or other assets.
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