Don’t overpay your Capital Gain Tax

Most of us will know the ins and outs of income tax as we all pay this on a regular basis through PAYE. However, “capital gains tax” is a lesser known tax which may impact those people investing outside of tax-wrapped investments. Minimising capital gains tax through legal channels and appropriate planning is positively encouraged (even by the tax-man) and we’ll show you how.

 

What Is Capital Gains Tax?

Before we look at how to minimise capital gains tax on property in the UK, we need to make sure we understand exactly what capital gains tax is. I’ll let the HMRC do the talking here.

Capital Gains Tax is a tax on the profit or gain you make when you sell or ‘dispose of’ an asset.

It was first introduced in 1965 by the chancellor James Callaghan to stop people minimising income tax by switching their income to capital gains.

 

When Do I Pay Capital Gains Tax?

You pay capital gains tax when you dispose on an asset, which is defined as being as soon as you cease to own it, including the following examples:

• sell it
• give it away
• transfer it to someone else
• exchange it for something else
• receive compensation for it – for example you receive an insurance payout when an asset has been destroyed

It’s the gain you make (simply the sales price less the purchased price) – not the amount of money you receive for the asset – that is taxed.

 

 

What Are The Capital Gains Tax Rates?

The first way how to minimise capital gains tax is to make sure you are maximising the “Annual Exempt Amount”. This means that the first £11,000 in the 2014/15 tax year (increasing to £11,100 in the 2015/16 tax year) of gains will not be taxed.

Basic rate income tax payers shall then pay capital gains tax of 18% on any capital gains over £11,100, with higher rate income tax payers paying 28%. See the section at the bottom of this article to show how this has changed as a result of the 2016 budget.

 

Capital Gains Tax Example

You bought some shares for £2,500 in June 1992. You sell them for £22,500 in May 2013.

You’ve made a gain of £20,000 (£22,500 less £2,500), which is subject to capital gains tax.

Therefore, the first £11,100 would be tax free, and you would have a taxable gain of £8,900. Assuming you are a basic tax rate payer, your capital gains tax bill would be £8,900 x 18% = £1,602.

 

How To Minimise Capital Gains Tax On Stock Market Investments

It is extremely important to understand the ways to completely minimise capital gains tax. In the UK, there are two significant ways to protect your investment returns (both capital gains and income from dividends) from tax.

The first of these is an ISA and the second is a pension/SIPP. Both of these options protect your investment returns from capital gains taxes, but in different ways.

Rather than going into too much detail in this post, I would recommend that you read the following to understand the tax benefits of these two tax wrappers:

Related Article: ISA vs Pensions (Moneystepper)

 

How To Minimise Capital Gains Tax On Property

However, most people run into problems when they try to minimise capital gains tax on property. Currently, residential property cannot be held in either an ISA or a pension. Therefore, it is not possible to wrap the investments from tax in this manner, making minimising capital gains tax a little more complex.

However, there are still certain rules and regulations that we can take advantage of to help us minimise capital gains tax.

Firstly, it is important to understand that you should never pay capital gains tax on the sale of your own residential property. For many people, this is the most common cause of a significant capital gain, and hence this relief will be very welcome.

For buy-to-let property, your tax bill can be greatly reduced if you have lived in the property yourself. This is called PPR (Principal Private Residence) relief and it is applicable where you can prove that a sold property was, at any point during ownership, your home.

Essentially, the “final” 3 years (36 months) always qualify for relief. This applies even if you weren’t living there during the final 3 years. Instead, the rule is that the property must have been your only or main home at some point during the time that you’ve owned it.

You actually then can claim PPR relief on the actual time you were living in the property, plus the additional 3 years.

Unfortunately, in his autumn 2013 statement, the Chancellor announced that from 2014-15 this final period relief will only apply to the final 18 months of ownership. There will be an exception for people who are disabled or in long-term care.  This measure became law in 2014.

 

How To Minimise Capital Gains Tax Through Letting Relief

Additionally, many landlords will also be able to claim letting relief when they sell their buy-to-let property.

The maximum amount of Letting Relief due is the lower of:

• £40,000,
• the amount of Private Residence Relief due, or
• the amount of gain you’ve made on the let part of the property

This relief can then be placed against any of your gains and you will not be required to pay capital gains tax on this amount.

 

How To Minimise Capital Gains Tax On Property UK – An Example

To bring all of these items together and give us a wider appreciation of how to aviod capital gains tax on property in the UK, an example will come in handy.

Say you bought a property in 2004 for £100,000, which you lived in until 2006. You then rented this property out until 2014, when you sold the property for £220,000.

Your capital gains initially seems like it will be payable on £120,000, which for the higher rate tax payer would lead to a bill of £33,600.

However, firstly we know that we can benefit from PPR. We owned the property for 10 years, so 1.5/10 of our gains are excused (as per the new guidance). However, we also get the time that we actually lived in the property tax free as well. Therefore, our 2 years living and extra 1.5 years PPR are tax free (3.5 years in total).

In this scenario, the total PPR would be £42,000 and the taxable gain would be the remaining £78,000.

Then, letting relief will also be available for another £40,000.

Therefore, our new taxable amount is £120,000 – £42,000 – £40,000 = £38,000.

After removing your annual exempt amount of £11,100, there would only be capital gains to pay on £26,900 under the new rules), meaning a final tax bill of only £7,532.

By understanding the tax exemptions available; we have completely legally and ethically minimised over £26k in capitals gains tax!

But, there are yet more ways that you can minimise capital gains tax on property in the UK…

 

 

Extra Tips To Minimise Capital Gains Tax – The Power Of Partnership

Each person owning any property can claim both letting relief and place their annual allowance against the sale.

Spouses can only use both partners’ reliefs and annual exempt amounts if they both own the property. Therefore, if you have a property which is solely held by one partner, it may save you thousands by gifting half of the property to the other spouse before selling.

As long as the property transfer is a “gift” – i.e. that there is no money changing hands and no change in who is liable for the mortgage – there will be no capital gains tax due on the gift between the spouses. Then, when the property is sold to a third party, the reliefs available will be much more generous.

Therefore, in the above example, if a husband and wife had bought and sold the property jointly, the taxable amount before annual exempt amounts would have been:

Gross gain                                            £120,000
PPR relief                                              (£42,000)
Husband letting relief                          (£40,000)
Wife letting relief                                  (£38,000)

Taxable gain                                          £0

 

Note that the wife could have used up to £40k letting relief as well, but this was not required. Additionally, if a taxable gain is due before annual exempt amounts, both the husband and wife can apply their annual exempt amounts to this gain.

For example, under the same example, with the only difference being a sales price of £260,000:

Gross gain                                               £160,000
PPR relief                                                 (£56,000)
Husband letting relief                             (£40,000)
Wife letting relief                                     (£40,000)

Taxable gain                                             £24,000

Husband’s annual exempt amount     (£11,100)
Wife’s annual exempt amount             (£11,100)

Final taxable gain                                     £1,800

Therefore, despite us starting with a taxable gain of £160,000. we actually only pay capital gains tax on a measly £1,800, which for a basic rate payer at 18% would amount to £324.

 

 

Extra Tips To Minimise Capital Gains Tax – Capital Losses

Whilst you are taxed on capital gains, it is also worth noting that you can “store up” any losses you make to place against future capital gains:

 

For instance, if I bought a share for £10,000 in 2012 and it went into administration in 2014 and I received nothing back, I would have a £10,000 capital loss.

If in 2016, I sold a property for a gain of £25,000, I could then use this previous loss to reduce my capital gain by £10,000.

Always remember to use your Annual Exempt Amount before using any brought forward capital losses from prior periods.

For example, if you have a gain of £10,000 in the current year, you are covered by the annual exempt amount and therefore would not pay any tax. Therefore, you should not use any of your prior year losses.

Equally, if you have a gain of £15,000 in the current year (and £10,000 losses carried forward), you would only want to use £3,900 of your prior year losses to reduce your capital gains down to the tax free amount of £11,100.

 

What Rate Do You Pay For Capital Gains Tax?

After using your reliefs and allowance, the tax rate which you apply to your taxable gain can be a little tricky to work out. Effectively, the easiest way is to think of it as follows:

1. Take you current income for the tax year (the amount on which you pay income tax) and subtract it from the high end of the “basic rate tax level”. For the 2015-16 tax year (see the government website for latest figures), this figure is £31,785.
2. If the remaining figure is positive, you pay 18% tax on your capital gains up to that amount, and then 28% on the remaining capital gains.
3. If the remaining figure is negative, you pay 28% on all of your taxable capital gains.

See the section below to see how this will change as a result of the 2016 budget.

Back to an example. In the latest example above, the remaining taxable capital gain after reliefs and allowances was £1,800. If in this example your taxable income (your salary) was £31,000 per annum, then you would follow the steps above:

1. Take the current income of £31,000 away from the high end of the basic rate tax band (£31,785) to give £785.
2. The remaining figure is positive and so you would pay 18% on the £785, and 28% on the remaining gain of £1,800 less £785, which is £1,015. Therefore, the tax bill would be £425.50 (18% x £785 + 28% x £1015).
3. Not applicable.

 

Changes to Capital Gains Tax Rates in the 2016 Budget

In the 2016 budget, Mr Osborne has altered the rates of capital gains tax for capital sales made from April 2016 onwards. This effectively reduces the basic rate from 18% to 10% and the higher rate from 28% to 20%.

As per the government paper however:

This measure reduces from 6 April 2016 the 18% rate of CGT to 10% and the 28% rate of CGT to 20% for chargeable gains, except in relation to chargeable gains accruing on the disposal of residential property (that do not qualify for private residence relief), and carried interest.

Therefore, if you are selling a property that is not eligible for PPR relief, then you will still be charged rates of 18% as a basic rate payer and 28% as a higher rate payer.

The justification is that the government is trying to encourage individuals to invest in the stock market (into companies) rather than into property, presumably with the intention of slowing down the growth of the property market and helping with affordability for first time buyers.

 

How To Minimise Capital Gains Tax UK – Conclusion

Capital gains tax is simple for straight forward investing in stock markets. Invest in an ISA or pension/SIPP and you will completely avoid any capital gains.

If you cannot invest inside these tax wrappers (for example with property), it is essential that you understand the HMRC tax rules in order to greatly minimize any potential capital gains tax you would be paying.

You will hopefully find the HMRC capital gains tax section and the 2015/16 tax tables a great starting point to minimizing your tax bill.