You can incur a Capital Gains Tax (CGT) liability when you dispose of a valuable asset which has increased in value. This includes selling it and making a gain, gifting or donating it, exchanging it for something else or receiving compensation due to the loss, theft or damage of the item. You do not need to pay CGT on disposals which have not resulted in a gain.
For many, the annual CGT allowance means that gains can be made without needing to pay CGT. For the tax year 2020/21 the allowance is set at £12,300 for individuals and £6,150 for trusts. However, for those with significant assets and those in higher and additional rate income tax bands, effective tax planning can be beneficial to reducing your CGT and retaining as much money as possible.
To help you reduce your CGT, make use of these 10 tax strategies:
1. Make use of annual exemption
The annual CGT exemption cannot be carried forwards. This means that if you make no disposals in one year, you cannot carry that exemption forward to use together with the following year’s exemption. One way to reduce your CGT liability is to therefore to spread the disposals across multiple years, or if only making disposals on a shorter term, you may want to split them between either side of a financial year (6 April – 5 April).
2. Offset gain with losses
Disposing assets at a loss can be a strong tactical move when it comes to cutting your CGT bill. Unlike the CGT allowance, you can carry losses forward to offset against gains made in future years. If you are planning to sell an asset that will attract a large CGT bill, you may also want to consider disposing of other assets which aren’t as valuable as they once were – such as poor performing investment stocks and shares. The loss made on this disposal can then be used to offset against the CGT bill arising from the more profitable disposal.
3. Consider investments other than residential property
Whilst buy-to-let properties are a popular investment opportunity, when it comes to releasing the capital from them, they will always attract a much higher rate of CGT (18% for basic income taxpayers and 28% for higher and additional rate income taxpayers). By diversifying your investment portfolio, you can minimise the tax percentage that eats into your gains.
4. Consider tax-free investments such as SEIS or EIS
For serious investors, making investments through the Seed Enterprise Investment Scheme or Enterprise Investment Scheme can be incredibly lucrative. All gains made are free from CGT so long as the shares are held for at least 3 years. Not only that, but if the shares are sold at a loss, the loss can be elected to be offset against personal income instead of capital gains. This is especially useful for higher rate and additional rate taxpayers as income tax is charged at much higher rates than CGT. Note that investment in these schemes are considered to be high-risk so we would recommend seeking advice from a professional financial advisor before proceeding.
5. Utilise ISAs and Bed & ISA
ISAs are often overlooked, but they’re a highly flexible investment option. Any gain realised from ISAs are CGT-free, as is any income earned from ISAs income tax-free. For additional rate taxpayers who do not have the personal savings allowance, ISAs should not be ignored. When using a Bed & ISA, it means you sell a non-cash asset, only to purchase it back through the ISA. This means any future gain acquired can be enjoyed tax-free. This option can be useful where you do not have cash to invest in an ISA but do have long term assets that you would like to keep.
6. Pay into a pension fund
Reducing your CGT by paying into a pension fund is most effective for higher and additional rate taxpayers. This is because when you pay into a pension fund, you receive tax relief from the government by way of extending your basic rate income tax band. If you put £1,000 into your pension and your annual salary is £55,000, you will only need to pay 40% income tax on £4,000 of your earnings instead of £5,000 (and 20% income tax on everything else excluding your personal allowance). The more you can extend your basic rate income tax band, the more scope you will have for CGT to fall into the lower rates. If you’re not sure how this works, see our article on capital gains tax which explains how to calculate how much CGT you pay.
7. Donate to charities
Donating to charities helps reduce your CGT in a similar way to paying into a pension fund. However, there are caps when it comes to paying into a pension fund – either the equivalent of your annual salary or £40,000 (whichever is lower). If you have maximised on this opportunity already, then you may want to consider donating assets or cash to a charity. This again extends your basic rate income tax band and allows for more CGT to fall into the lower rates.
8. Use your spouse’s exemption
For married couples or civil partners, you can transfer assets and cash tax-free between each other. If you have already fully utilised your own CGT exemption, then you may want to consider transferring the asset to your spouse or partner for them to dispose of, thereby utilising their own exemption. Together, this means you can earn gains of up to £24,600 CGT-free per year.
9. Bed & Spouse
Another strange term, but the concept is similar to Bed & ISA. It originally stems from the practice of ‘bed and breakfasting’ which is to sell shares only to repurchase them again the same day. The reason for doing this is that where the shares go up in value, you dispose of them and utilise your CGT exemption to cover any gain. You buy them back because they are likely to continue increasing in value. When you dispose of them in the future, the gain will be calculated between the repurchased higher value as opposed to the original value when they were first purchased. This practice has now been abolished by a 30-day rule which dictates that 30 days must elapse before you can buy the same shares again. However, a legitimate loophole around this is to sell the shares and get your spouse or partner to purchase them. That way you can keep valuable assets within the family whilst still minimising any CGT when it comes to future disposals.
10. Elect for holdover relief
Holdover relief allows you to avoid CGT when you gift business assets (or certain types of shares) to someone or sell it to them for a lower price than their value. There are certain qualifying criteria in order to be allowed to do this, but if holdover relief is used, it means you pass on the CGT liability to the recipient should they dispose of the asset in the future. Not only that but their CGT will be calculated based on the difference in value of the asset at the time of their disposal and the original cost to you. To illustrate, say that you gifted a piece of land to your child that cost you £10,000 but was worth £50,000 at the time of transfer. Were you not to use holdover relief, your CGT would be calculated based on £40,000 worth of gain. With holdover relief, you pay no CGT but should your child sell the land in the future and it increases in value to £100,000, their CGT would be calculated based on £90,000 worth of gain. Holdover relief is not applied to CGT automatically and must be jointly claimed between yourself and the recipient. For help with claiming holdover relief, please get in touch via the contact form so that we can assist you.
There may be further ways you can reduce your CGT which are dependent upon your individual circumstances. If you are making large disposals and want to minimise your tax liability, book a free consultation by completing the form below to find out how we can help.