Reducing your liability to capital gains tax (CGT) requires planning and careful use of the capital gains tax relief provisions.
Below we look at some of the main forms of tax relief against CGT and how you can maximise their use so as to minimise your tax bill.
What is capital gains tax?
Capital gains tax is the tax charged on the profit, or gain, made when you sell, gift, transfer, exchange or otherwise dispose of a ‘chargeable asset’.
For individuals, a chargeable asset can include a property that is not your main residence, such as a holiday home or a buy-to-let property. It can also include valuable personal possessions, as well as stocks and shares that are not held in tax-free savings accounts.
For sole traders or partnerships, chargeable assets can include business premises or other business assets, including copyright and registered trademarks, or even goodwill.
What is the capital gains tax rate?
When calculating your liability to capital gains tax, you will need to add together your total gains in any given tax year over and above the annual exempt amount.
Individuals, sole traders and partnerships are entitled to an annual allowance of £12,300 (2020-21). Any gains falling below this threshold are entirely tax-free.
You must then take any chargeable net gains and add these to your annual income. In the event that your gains and income, taken together, fall below the basic rate threshold for income tax, you will pay capital gains tax at the standard rate. Any excess will be charged at the higher rate.
For basic rate taxpayers the applicable CGT rate is 20% for chargeable gains made on residential property, and 10% on all other gains. For the higher rate taxpayer the rates are 28% and 18% respectively.
Are any assets exempt from capital gains tax?
You do not have to pay tax on all capital gains, where some assets are wholly exempt. These include the following:
- Wasting assets – the primary example here is private cars, where these have a predictable life of 50 years or less. Other items with a limited lifespan include plant and machinery used in a business.
- Personal possessions worth less than £6,000 – here you are looking at the disposal value rather than the extent of any gain. As such, if the sale proceeds or market value of the asset in question is below £6,000, this will be CGT exempt.
- Stocks and shares held in ISAs and PEPs – if you own stocks and shares but these are held in a tax-free savings account, no liability to capital gains tax will arise.
- Winnings – any win from betting, lotteries or games with prizes are not chargeable gains.
- Inherited assets – typically, when someone dies there is no capital gains tax charge, although the estate may be subject to inheritance tax. That said, a CGT liability can arise if, and when, an inherited chargeable asset is sold or disposed of.
What are the main forms of capital gains tax relief?
In the event that your chargeable gains exceed the annual tax-free allowance, you can still reduce or defer your CGT liability by making use of any available capital gains tax reliefs.
The following are examples of some of the main forms of capital gains tax relief:
Principal private residence relief
Typically, all or part of the gain on the disposal of a dwelling house that has been your main or only residence at some point will be exempt from capital gains tax under private residence relief.
You will be eligible for partial relief for the period of time that you were in occupation, with no minimum requirement on how long the property was deemed your main or only residence. You will also be entitled to relief for the final 18 months of your period of ownership.
If you own property which has at some point been your main residence, and which you have also let out as a residential property, you may also be eligible for letting relief.
Letting relief will allow you to claim either the lower of the amount of private residence relief, the sum of £40,000, or the amount of the gain arising by reason of the letting.
Business asset rollover relief
If you are a sole trader or partnership, you may be able to delay or ‘roll-over’ paying capital gains tax if you sell or dispose of any business asset(s) and use all or part of the proceeds to buy a replacement.
Any liability to capital gains on the original asset only becomes payable when the new asset is sold. However, to qualify you must buy the new asset(s) within 3 years of selling or disposing of the old one(s).
In broad terms, entrepreneurs’ relief provides for an effective rate of 10% on gains made from qualifying assets when selling all or part of your business.
To qualify for relief, you must be a sole trader or business partner, and have owned your business for at least one year before the date you sell it. You must also dispose of your business assets within 3 years.
Additionally, there is a lifetime cap of £10 million.
Gift holdover relief
Where a business asset is sold or gifted at an under-value, gift holdover relief provides the original owner and recipient the opportunity to jointly defer the gain arising during the period of previous ownership.
This instead becomes payable by the new owner at the point of future disposal.
Gift holdover relief can also to apply to other types of assets.
In what other ways can I reduce my CGT liability?
In addition to capital gains tax relief, there are a number of other ways that you can reduce or defer your CGT liability. These include the following:
- Use your tax-free allowance against the gains that would be charged at the highest rates, for example, where you would be liable to pay 28% on residential property.
- Offset any losses from previous years against any gains made in subsequent years. Note that only capital losses, and not allowances, can be carried forward to another tax year.
- Defer the sale or disposal of an asset where your tax-free allowance has been exceeded for that year or, alternatively, where immediate disposal of the asset would otherwise expose you to capital gains tax in the higher bracket.
- For those of you who are married or in a civil partnership, you are free to transfer assets to each other without any CGT being charged, effectively doubling the annual allowance that can be used. However, the transfer to your spouse or partner must be a genuine outright gift.
Key takeaway for capital gains tax relief
Through advance planning and careful application, you can take advantage of the available capital gains tax reliefs and exemptions, or by making use of the best available rates. In this way you may be able to significantly reduce your liability to CGT, or defer it to a later date.
However, you will need to regularly review your tax affairs to ensure that you remain up-to-date with any changes to the rules, and apply them in the most tax-efficient manner for you and/or your business at any given time.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute tax, financial or legal advice, nor is it a complete or authoritative statement of the rules and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert tax, financial, legal or other advice should be sought.