How to beat capital gains tax

Labour’s first Budget since the General Election is nearing, and having ruled out increases to some other taxes, capital gains tax is one of the menu options likely to appear most appetising to the chancellor.

Reports suggest new Chancellor Rachel Reeves’ Treasury team may have settled on increasing the rate of capital gains tax to 24% or 28%. While that won’t win any cheers among investors, some will be breathing a sigh of relief if the chancellor stops short of a more radical increase in capital gains tax rates.

The chancellor could consider restoring the capital gains tax allowance to protect small shareholders from a double-whammy tax hit. In recent years the capital gains tax allowance was cut from £12,300 to just £3,000, dragging small investors with relatively modest gains into the tax net. If the rate of capital gains tax goes up they will receive a double-whammy on the back of the reduced allowance, which was cut to its current £3,000 as recently as April this year and stood at over £12,000 until 2023.

It’s difficult to predict with certainty what changes to capital gains tax may be implemented and when. Importantly, it’s not clear whether any hike would come in on Budget day, or from 6 April next year.

On the one hand implementing the change immediately prevents forestalling. But the chancellor may decide to leave a window of opportunity for gains to be realised, in the hope that drives a bumper tax haul in the near term. Previously hikes have happened in year, and capital gains tax is currently calculated on a ‘per tax year’ basis, so there would be less of the disruption to investors than an in-year change to taxes on earnings. A pause until the next tax year, rather than an immediate hike, could actually raise more revenue as investors might bring forward sales they were already considering.

How to beat capital gains tax

Capital gains tax planning is a key part of the investor toolkit. There are a range of ways to mitigate capital gains tax and avoid paying more tax than you need to.

Use up (or lose) your allowance

If you’re sitting on large capital gains outside an ISA or pension, it generally makes sense to realise gains up to your capital gains tax-free limit each year. If you sell investments to realise gains up to this level, you won’t pay any tax on the money. You just need to check what gains you’ve already realised this tax year, across all your investments, and make sure you don’t exceed the tax-free limit. It’s a use it or lose it situation, so you can’t carry forward unused capital gains tax allowance to the next year.

Just be careful if you intend to buy the same holding back outside of an ISA or SIPP. If you do this within 30 days, then you would be deemed to have bought it back at the original cost and not realised any gains. This tax avoidance method is sometimes known as the ‘bed and breakfast’ rule.

Fill your ISA

If you have investments outside a tax wrapper the savviest move is to transfer that money into an ISA, or into a pension if you can afford to tuck it away for longer. You’ll need to check how much ISA allowance you have remaining this tax year to make sure you don’t go over the £20,000 annual limit.

If you want to make the most of your allowances and keep the same investment(s) then you might consider a Bed and ISA transaction. This involves selling an investment and using the cash proceeds to buy it back within the ISA as quickly as possible. There might be stamp duty and dealing costs to pay but any gains going forward will be completely tax free. Make sure you check any deadlines and timelines for completing the process with your investment provider.

Transfer money to your spouse

Any investments transferred to your spouse or civil partner are exempt from capital gains tax. This means that if your spouse hasn’t used up their tax-free allowance this year and has some ISA allowance remaining, you can make use of those tax breaks. You just need to make sure you keep a note of the original cost of the asset, as that’s what will be used when your partner comes to sell it.

If your spouse is in the basic rate income tax bracket but you’re a higher or additional rate taxpayer there’s a double benefit, as current rules mean they will pay capital gains tax at a lower rate.

Use your losses

While no investor wants to make a loss, losses can be your friend for capital gains tax purposes. Losses made in the current tax year can be offset against any gains before you deduct the tax-free allowance. If you don’t use them this year you can carry forward any losses for future tax years, to offset against any future gains. Just make sure you register the losses with HMRC within four years after the end of the tax year in which you made the sale in question.

Use pension contributions

One particularly clever trick is to use your pension contributions to reduce your income tax band. When you contribute to your SIPP, the gross value of the contribution has the effect of extending your basic rate tax band. This means that under current rules, the rate of capital gains tax you pay could be lower if it means you are no longer a higher-rate taxpayer. This is a particularly handy trick if you’ve only just tipped over into the next tax band, meaning a small pension contribution would bring you under the threshold.

This planning tool works under the current system, but if capital gains tax rates are equalised, it would cease to be of benefit.