Record capital gains tax grab: how to reduce your bill

With capital gains tax at its highest level on record, Alice Guy looks at how the tax works and ways to cut your bill.

2020-21 was a record-breaking year for the taxman. Capital gains tax (CGT) raised £14 billion in total, 42% more than the previous year. And more taxpayers footed the bill, 323,000 paying CGT during 2020-21, an increase of 53,000 from 2019-20.

Alex Davies, chief executive of Wealth Club, commented that “this is a steep increase on the amount received in the previous year, which is put down to media speculation about changes to CGT rules, policy changes affecting eligibility for certain reliefs, and also to a lesser extent, an increase in the number of buy-to-let disposals as a result of the change in tax rules”.  

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How does capital gains tax work?

Capital gains tax is charged on the profit from the sale of shares, investments, second properties and businesses.Each tax year, taxpayers get a CGT annual allowance of £12,300, after which CGT is due. If you don’t use your allowance, it cannot be carried over to the following year.

For example, if you bought a buy-to-let property in 1990 for £100,000 and sold it in 2022 for £450,000, your initial capital gain would be £350,000. Let’s assume you spent £50,000 improving the property by building an extension and £20,000 on legal, estate agent and other fees when you bought and sold the property. Your total capital gain would be £280,000 and your taxable gain would be £267,700 (£280,000 minus £12,300 annual exemption). Assuming you are a higher-rate taxpayer, the tax due would be £74,956 (28% of £267,700).

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Capital gains tax traps

Complicated rules mean that it’s possible to become caught in the capital gains tax net unintentionally.

For example, homeowners normally get a CGT exemption for their main home, but they may lose out if they move house and hold on to their old home for more than 18 months. That means if you moved and didn’t sell your house for two years, you might have a CGT charge for the extra six months.

Taxpayers also sometimes forget that gifting an asset is the same as selling it, as far as the taxman is concerned. That means if you gift a rental property to your child, you’ll have a CGT bill to pay on the difference between your selling price (HMRC uses market rate if you gift a property or sell it for less than the market value) and purchase price.

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How to minimise capital gains tax

The good news is there are still several steps you can take to minimise your tax bill. Here are some possible ideas:

• Use your ISA allowance: you can invest up to £20,000 in an ISA each year, or £40,000 as a couple, and any gains will be exempt from CGT and income tax.
• Bed and ISA: this is when you sell assets, and rebuy them within an ISA. You can either realise a gain or try to keep your gain under the annual allowance. Be careful, because even a short time out of the market can reduce your long-term wealth if the asset jumps in value.
• Use your pension: you can invest up to £40,000 per tax year in your pension, or £4,000 if you’ve started to draw a pension income. Again, any gains are exempt from CGT and income tax. 
• Transfer assets to a low-earning spouse: transferring or splitting the ownership of assets with your spouse, means you can both use your annual allowance when you come to sell. You can also save on tax if they are a basic-rate taxpayer as they will pay CGT at a lower rate.
• Use your losses: CGT losses from previous tax years can be offset against gains, if you report the losses to HMRC within four years from the end of the tax year you sold the assets.

Other tax-saving schemes

To encourage investment, there are also a range of schemes – some risky – that investors could consider.

Alex Davies comments that, “Pensions and ISAs are great, but the allowances can be restrictive for some. To mitigate this, if you’re prepared to take extra risk, you could look to the government’s venture capital schemes. Each offers a different mix of tax benefits. Which you go for will largely depend on circumstances and how much risk you’re prepared to take. As a rule of thumb, the greater the tax benefits, the higher the risk.

“Venture Capital Trusts (VCTs) offer up to 30% income tax relief. Returns are paid through regular tax-free dividends, which is a nice bonus, and any gains are CGT free. The allowance is a very respectable £200,000 a year.

“Enterprise Investment Scheme (EIS) investments also offer up to 30% income tax relief. There are no tax-free dividends, but one bonus here is that you can also defer capital gains. For as long as you stay invested in any EIS, you can forget about the CGT bill. It will only become payable once you come out of the EIS, unless you re-invest the money into another. The EIS allowance is a whopping £1 million a year or £2 million if you invest at least £1 million into “knowledge intensive” companies. 

“The SeedEnterprise Investment Scheme (SEIS) is the most generous when it comes to tax savings. When you invest, you can get up to 50% income tax relief and 50% capital gains tax reinvestment relief. The allowance is more modest but still sizeable at £100,000. Nonetheless it means a £100,000 investment could save you up to £50,000 income tax plus £14,000 capital gains tax (assuming you have paid 28% CGT on the sale of a property).”

If you’re thinking about investing in one of these schemes, then it’s a good idea to get financial advice. The rules are complicated and if the schemes are right for you will depend on your circumstances.

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