Tax Basics |
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Watch out for capital gains tax
Capital gains tax can have a nasty habit of creeping up and landing you with a hefty bill from the Inland Revenue when you least expect it. Over the past decade, individual capital gains tax (CGT) allowance - the amount When individuals make money by selling assets other than their main home, such as a buy-to-let property or shares, they are often liable to CGT. But as it is a tax usually payable on sale, many investors may be too busy celebrating their profits to consider its impact. Experts warn that investors can easily slip over their limit when selling a big item, such as a second home or buy-to-let property. There are some exceptions to CGT. Your main home is exempt, as are investments held in individual savings accounts, plus other items such as cars and assets worth up to £6,000. Any taxable gains above the £9,200 allowance - the difference between the amount the asset was bought and sold for - are taxed at one of three rates depending on which band the gains fall into after all other income has been taken into account. For the current tax year, if your taxable income and gains after the annual exemption are below £7,455, CGT is levied at 10%; if they are between £7,455 and £39,825 you are taxed at 20%; and if above £39,825, at 40%. Lessen the CGT burden So how can you lessen the CGT burden and enjoy more of your profits? Planning ahead to prepare for CGT can save you a tidy sum. One of the most simple and effective uses of the annual personal allowance is for couples to hold assets in joint names to double it to £18,400 before CGT is payable. Provided you don't go over that limit, you won't have to pay any CGT, as long as you have not used up any of the allowance by disposing of other assets in the same period. Other than the basic allowance, reliefs on offer include capital gains taper relief. Put simply, this means the longer you hold the asset, the smaller the tax bill. Once an asset has been owned for three full years, the capital gain is discounted by 5%, with a further 5% taken off each year up to a maximum of 60% after 10 years. This taper relief is taken off before any annual exemption is available. If you have let your property as a corporate rental to an unquoted trading company or business, you may qualify for the much more generous business asset taper relief, giving you a 75% discount on your capital gain after only two years. For property investment, the real saving comes if at some stage you have used it as your principal private residence. Principle private residence relief (PPR) means you don't normally face paying CGT on gains you make when selling your main home - and you can also make use of it for other properties you own. If you own more than one home, you can nominate which one qualifies for PPR. But you must notify your tax office of your choice within two years of getting a further home. Investment property If you own an investment property, you can still benefit from PPR by using it as your main home at some point before you sell it. This will give you the last three years worth of growth free from CGT as well as the period in which you live there. HM Revenue and Customs does not specify how long you need to have lived there, but may ask for proof. If you let the property out at some stage you will be entitled to up to £40,000 letting relief against your capital gain and this is available for each owner - so if it is in joint names, this doubles to a maximum £80,000. However, letting relief is only applicable to properties which have at some point been your main home. Legal fees and stamp duty count as part of the cost of buying a property, as do selling costs such as estate agent fees - and these can be offset against any gains. For example, if a couple paid £5,000 in costs when buying the house and £10,000 when selling, their £100,000 taxable gain on the sale (before taking any CGT allowances into account) would be reduced to £85,000, which can be further lowered by calculating the costs of any capital improvements. If any significant alterations have been made to the property while you have owned it the cost of these can also be taken off the gain. Minor refurbishments such as repainting walls do not count. By the time you take off taper relief and the annual exemption, you will find that a large part of the capital gain has disappeared. This does not just apply to a second property, but could also apply to a third or fourth property, both in the UK or overseas. Shares and units trusts Profits made on shares and units trusts are also liable to CGT, as are shares in investment trusts. However, there is no CGT on government bonds (gilts), National Savings Certificates, shares or units held in an ISA or pension (including self-invested personal pensions, or SIPPs), venture capital trusts or shares held for at least three years in an enterprise investment scheme. Making use of your tax-efficient ISA allowance is always important, even if £7,000 seems like a small part of your overall portfolio, as it can add up over the years. While the 'bed and breakfasting' CGT loophole was closed in 1998, 'bed and ISA' is a common form of tax-planning. You sell £7,000 worth of unit trusts or shares and buy them back within an ISA wrapper. To maximise your CGT relief when crystallising gains from shares, you can also still do something called 'bed and spousing', where you sell your shares one day and your spouse buys them the next. As Andrew Penman points out, this is a useful means of manipulating sales to use up annual exemptions without actually removing an asset from a couple's joint portfolio. Another useful investment principle is 'last in first out', especially for those who save regularly into unit trusts or top-up share or unit trust portfolios. If you want to avoid being hit by a nasty CGT surprise, the HMRC has a range of help sheets on CGT, allowances and the various reliefs available. Alternatively, if there's a complex tax issue you want some advice on or you're looking to mitigate your CGT liability, find a local IFA with experience in tax planning.
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