Legally avoid capital gains tax
Capital Gains Tax (or CGT for short), is usually paid on the sale of assets, most commonly shares or a second property. Capital gains tax can also be charged if you give the asset away – both a sale and giving it away would count as a disposal. CGT is probably one of the more difficult taxes to avoid legally.
Capital gains tax - key points:
- CGT is payable on the sale or disposal of an asset which has provided you with capital growth, such as an investment fund, shares or a second property.
- There is a distinction between property and non-property assets (such as shares).
- The rate of CGT on property gains is 18% for basic rate taxpayers or 28% for higher rate taxpayers. For non-property assets this is either 10% or 20%.
- From April 2024 only the first £3,000 of any gain is exempt from Capital Gains Tax (although it used to be £12,000).
- Costs of buying and selling the asset can be deducted from the the gain.
Worked example of how CGT applies
Mr Smith bought an asset for £100,000. 10 years later he sells it for £205,000 in May 2024. He has costs in the sale of £5,000.
He therefore has a gain of £100,000 after deducting the sale costs. The CGT allowance of £3,000 is deducted from the £100,000, so he has a gain of £97,000 that is subject to Capital Gains Tax.
Mr Smith is a higher rate taxpayer, and earns £100,000 per year from his employment. Below the tax paid is shown if the asset was shares and contrasted if it was a second property.
Tax liability if asset were shares
As Mr Smith is a higher rate taxpayer so he will pay CGT at a rate of 20% on the £97,000, which would amount to £19,400.
Tax liability if asset was a second property
As Mr Smith is a higher rate taxpayer, and it was a property asset he will pay CGT at a rate of 28% on the £97,000, which would amount to £27,160.
There are some steps you can take to reduce the CGT payable. Some more effective than others. They are:
- Always make sure you deducted the sale and purchase costs.
- Consider staggering a sale. For example, with shares it may be possible to sell half of the shares in one tax year, the remaining half in another tax year. This may allow you to use two lots of CGT allowance, and depending on your income and whether you are a higher rate of basic rate taxpayer could mean less of the gain gets taxed at 20% or 28%.
- If you’re married or in a civil partnership consider gifting some of the asset to a spouse, this could give you two lots of CGT allowance, and potentially more in the lower rate of CGT (10% or 18%).
- Consider using an Enterprise Investment Scheme (EIS). See below for more details.
EIS and CGT
An EIS is a relatively higher risk investment that has a number of tax advantages. They can help manage and sometimes reduce the amount of CGT payable. If we continue with the example above of Mr Smith, a work example might help explain how they work. We’ll assume Mr Smith was a landlord and his £100,000 gain was from the sale of a property.
Mr Smith continued……..
Rather than pay the best part of £28,000 in CGT, Mr Smith decides to invest the gain of £100,000 into an EIS offering a portfolio service. This gives him:
- An immediate deferral of the £28,000 CGT liability, as he has effectively deferred the £100,000 gain. He still has to pay CGT on the gain at some point in the future, just not now.
- It would convert the asset from a gain in a property, to a gain in shares. So, upon eventual sale, it would be taxed as a non-property asset at a rate of either 10% or 20% depending on his other income at that time.
- He also has assets that are eventually “sellable” in different tax years, and over a period of time (unlike a property).
- The EIS also qualifies for income tax relief. This income tax relief is in addition to deferring the CGT. In Mr Smith’s example, he would pay around £33,000 income tax with an income of £100,000. The investment in the EIS would wipe out £30,000 of that income tax liability, so he’d only have £3,000 income tax to pay.
- In effect the £100,000 reinvested gain, has saved him £30,000 in income tax, and allowed him to avoid paying £28,000 now. Effectively means that this £100,000 invested has only at this moment in time cost him £42,000.
EIS - too good to be true?
An EIS sounds too good to be true. But the tax benefits are real, and they are many fully compliant EIS schemes. HMRC even publish information about the rules, and see information on the HMRC website by following this link. But there are some downsides to them:
- The rules state that they have to be held for at least three years from when the money is invested. In reality it can be much longer, as the company would need to be sold.
- This means that an EIS is not liquid. You have limited control about when you can get your money.
- It is relatively high risk, as the EIS may be just one company or a handful of companies. (But there is loss relief on an EIS, which means if the company or one of them you’re invest in goes out of business, you can get tax relief on the loss. So, if you invested £10,000 in one company and it goes out business, then that loss of £10,000 can reduce your current tax bill. For a higher rate taxpayer, this loss of £10,000 would reduce a tax bill by £2,800, (and he’d have received £3,000 income tax reduction when he invested the £10,000, so the actual loss could be just £4,200).
- There are quite complex rules around an EIS, and when you can claim tax relief.
- You can lose money on an EIS because of the risk of a limited number of companies, and the fact that they are small companies. However, the level of risk varies from provider to provider.
If you want to discuss any of the issues or want advice, have a question, or just want to have a chat about it with a UK Qualified Independent Financial Adviser, then phone now on 01793 686393 or contact us online.