What to do with your capital losses

Capital losses don’t have to be the end of the world. Yes, they can be disappointing or frustrating but from a wider perspective, when handled correctly, they can still act as a valuable instrument to your overall tax planning strategy and help reduce future capital gains tax liabilities. To ensure that they can be fully utilised however, be sure to take the correct and necessary steps in time which we’ll explain simply in this guide.

What is capital loss?

Capital loss describes the situation where you have disposed of an asset that has not maintained or increased in value since you first acquired it. So, if you give away, trade for another asset, or sell an asset for less than what it was worth when you originally received it then you’ll have suffered capital loss.

It’s really important to be clear that capital loss is distinctly separate to income loss (also known as trading loss) because capital loss only has an effect within the capital gains tax (CGT) system. This means that it does not ordinarily allow you to reduce any income tax liability when you have suffered capital loss and it can only help you reduce future capital gains.

When does capital loss arise?

Capital loss is triggered when a “chargeable disposal” takes place. In this phrase, “chargeable” is the term that describes a capital asset which is subject to CGT. Not all personal assets attract CGT. Examples of these include:

• Privately owned personal vehicles (this directly excludes vehicles owned by businesses)
• Personal effects which are sold for under £6,000
• Wasting assets which are items with a predicted useful life of less than 50 years such as racehorses or an antique clock
• Foreign currency that has been purchased for you and your family’s own personal use
• The property you live in as your main residence

So, in order for capital loss to take place it must firstly revolve around an asset that is subject to CGT. Then, we move onto the term “disposal” which does not simply occur only when selling an asset. It is often misunderstood that you cannot be liable for CGT where you give away item for free, but this is not the case. If the asset increases in value at the time the gift is made, it is treated as if you have also gifted the increase in value and tax is still due. Therefore, if the opposite were to happen where the gift you made meant the asset had reduced in value, you could still make a claim for capital loss. Common events where capital loss can arise include:

• Landlords selling up rental property from their portfolios due to market downturn, squeezed profits, and increased regulatory incumbrances.
• Closing down a limited company that has no longer become financially viable.
• Disposing of poor performing investment products such as bonds, stocks, and shares.
• Making a negligible value claim on shares.
• Liquidating assets such as cryptocurrency or gold bullion to raise cash during unfavourable market conditions.
• Selling or transferring assets to an ex-spouse due to divorce

Do you need to declare capital loss to HMRC?

There’s actually no legal requirement that you declare capital loss to HMRC. You’ll face no penalties for failing to do so. However, if you want to be able to make use of the capital loss to reduce any current or future CGT liability then the only way to do that is to first declare it.

To declare your loss to HMRC you can do this in one of two ways. If you are already registered for self-assessment and ordinarily complete an annual personal tax return, then you can declare the capital loss under the capital gains tax section of the tax return form. You need to include:

• A description of the asset disposed of
• The date of disposal
• Disposal proceeds
• Allowable costs
• The resulting capital loss

Once reported, the loss can be offset against gains in the same tax year or carried forward for use in future years.

If you do not ordinary submit a self-assessment tax return, then you can instead report your loss directly to HMRC in writing. For this, you should include the following information:

• Your personal details (including National Insurance number)
• Details of the asset disposed of
• Calculations showing how the loss arose

Whilst it’s best practice that you declare your capital loss by the 31^st January following the end of the tax year in which the loss occurred if completing via a self-assessment tax return or as soon as possible if simply writing to inform HMRC, the maximum time limit you have is 4 years from the end of the tax year when the loss occurred. Missing this deadline will result in losing the ability to use the loss to offset against capital gains.

How does a negligible value claim work?

A negligible value claim is a way of claiming capital loss for tax purposes without having the need to actually dispose of the asset. It’s most commonly used when shares or investments become virtually worthless. The negligible value claim treats it as if the asset has been disposed of and immediately reacquired for £0. HMRC allows for this method of claiming for an allowable capital loss because they recognise that some assets cannot be practically sold when they have no economic value.

In the same way as declaring other capital losses, you can either submit the information of your claim on your self-assessment tax return or write directly to HMRC. Your claim will only be approved if you can show:

• The asset has become effectively worthless over time — it cannot have been of negligible value when you originally acquired it.
• There is no realistic prospect of recovery. HMRC needs to be satisfied that the asset has no meaningful potential to regain or grow in value and that it is not simply a short-term dip.
• You still legally own the asset at the time you make the claim. For shares, this means submitting the claim before the company is dissolved as you’ll no longer own the shares in this case.

For a negligible value claim, you have the ability to choose whether the capital loss is held and carried forwards to be used against future capital gains or whether you want to set the loss against your income either in the same or prior tax year in which the negligible value claim is made.  This course of action can quite often result in a rebate of income tax.

How capital loss can be used against capital gains

Once your capital loss has been declared correctly to HMRC it can then be used to  reduce your CGT. However, there is a fixed procedure that must be followed which dictates how and when the losses can be offset against CGT. So, to avoid misunderstanding and missed tax planning opportunities, we’ve set out below how they can be used in practice, including the order in which they must be applied and the limited circumstances where additional relief may be available.

1) Use capital loss against capital gains in the current year

Capital losses will always be automatically used to offset against any capital gains realised in the same tax year first. Furthermore, if you have made both gains and losses in the year, then HMRC requires losses be deducted from your gains first before applying the annual CGT exemption. This means that not only can losses reduce your CGT liability, but it could potentially eliminate taxable gains all together. Even where it doesn’t, it can still be incredibly useful where gains have exceeded the annual exemption or where higher or additional CGT rates apply.

To illustrate, let’s say you sell some shares at a capital loss of £2,000. In the same tax year, you are also some antiques and make a capital gain of £4,500. The £2,000 can be used to reduce the gain down to £2,500 and the remaining amount is fully deducted from the annual CGT exemption. You therefore pay no CGT at all.

As a secondary example, say you are a basic rate taxpayer earning £45,000 a year. You sell an investment property and make a capital gain of £20,000, but in the same year, you also dispose of a commercial property making a loss of £10,000. By offsetting the loss and then claiming the £3,000 annual exemption, the remaining gain of £7,000 is taxed as £5,270 at 18% and £1,730 at 24%, giving a total tax bill of £1,364. Without the capital loss, £17,000 of the gain would be taxable after exemption, with £5,270 at 18% and £11,730 at 24%, giving a total CGT bill of £3,764.

2) Carry forward capital loss to offset against future capital gains

If you have not made any capital gains in the same year, then not to worry. The losses aren’t gone or wasted, but once (and only when) they have been declared they can be carried forwards indefinitely to be offset against future capital gains. If you had gains in the same tax year as the losses but remaining unused loss, this too is also carried forwards indefinitely. Once carried forward, losses must be used as soon as chargeable gains arise in a later tax year — you cannot choose to preserve the loss and use it at a later date for other future gains. In this case, it may be helpful to time the selling of poor performing assets at a similar time to disposals that will give rise to significant gains.

For example, you know you will need to close down your limited company in the next year due to retirement and expect it will attract a capital gain. As such, you begin to review your investment portfolio and dispose of some shares. Whilst some shares actually make you a gain of £3,000, other shares end up making a capital loss of £5,000. This means your gain is completely cleared when the losses are offset against it. Furthermore, you cannot use the CGT annual exemption because this can only be used against gains and cannot create further loss. The following year when you close down your company, you make a capital gain of £25,000. The remaining £2,000 of unused loss from the previous year and the annual CGT exemption bring down your taxable gain to £20,000 instead.

3) Can capital loss ever be carried backwards?

As a general rule of thumb, capital losses are offset against gains in the same tax year or carried forwards to the first available event of capital gains. You cannot usually choose to carry capital loss backwards. However, there are two exceptions to this rule:

First – capital loss can be carried backward if it has been incurred in the same tax year as an individual’s death as this would mean there cannot be future gains to offset the loss against. The unused loss can be carried back to the previous three tax years immediately before the year of death, applied against later years first. The executor of the estate must make this claim on the deceased’s behalf with HMRC and then the tax rebate forms part of the deceased’s estate.

The second exception to the carry backwards rule is where there has been deferred consideration. This happens in certain circumstances such as when you are selling a business as you may not receive the whole full payment in one go. It’s common for such assets to be sold with deferred consideration meaning that some of the payment is only made after based on certain conditions.

For example, you sell your business the buyers are willing to pay £100,000 up front and the remaining £50,000 after the first year of new ownership providing certain profit targets are met. You would then complete a CGT tax return for £150,000. But after the first year, the business misses the profit target and so the agreed final amount to be paid is only £20,000. The “earn-out” payment is therefore £30,000 less than expected and you can make a claim for this from HMRC. * For the simplicity of this example we have assumed that the £150,000 is the capital gain made and not the actual sale price of the business after allowable deductions.

4) Can capital gains ever be offset against income tax?

Whilst we did briefly touch upon this in earlier sections, we should be clear that although capital loss is usually restricted to being claimed against gains in the same tax year or future tax years, there are specific situations where HMRC will allow for capital loss to be set against income instead. This is particularly valuable because it can generate faster and more meaningful tax relief, especially for higher rate taxpayers. 

If you make a capital loss against shares in an unquote trading company, you may be able to seek loss relief against your income instead. For this to be approved, the company must be carrying out a trading activity, the shares were subscribed for in cash (not bought second-hand), the company cannot be listed on any recognised stock market, and the shares in the company must be worthless (often demonstrated when the company is insolvent or liquidating). In practical terms, this arises when start-up companies fail, a family business is closed down, or trading company is liquidated and there is no return to shareholders. Claiming for capital loss in this way allows you immediate tax relief against your income tax liability in the same year in which the loss occurs, and in some instances result in a cash rebate.

Another specific occasion where you can claim for capital loss against income is where you have made a capital loss against an SEIS or EIS investment. These are specialised tax schemes that inherently allow for this should loss occur in order to attract investment into high-risk companies. Not only this, but when it comes to loss from SEIS or EIS, you as the investor can choose how to offset the loss i.e. it does not automatically get offset against your capital gains first. This is incredibly valuable as income tax is charged at higher rates than capital gains tax so could help you reduce your tax liability significantly.

Get help turning your capital loss into smart tax planning

Don’t rule out capital losses straight away. When you take a broader perspective, you’ll be able to see that they can play a valuable role in your long-term future financial plans whether that’s selling a business, closing down a company, restructuring investments, or planning an exit. The rules around capital losses are strict, and timing is critical. Missed deadlines, incorrect claims, or overlooked reliefs can easily result in lost tax savings. If you’ve realised a capital loss — or think you might be sitting on one — we can help you understand how and when it can be used, as well as ensure it’s reported correctly to HMRC. Speak to our tax team today.