Maximise your capital gains tax exemption before the end of the tax year

Capital gains tax (CGT) applies to profits made on investments and assets held outside tax-protected wrappers like ISAs and pensions. Recent years have seen significant changes in this area, making it crucial to manage your CGT liability effectively.

Under the previous Conservative government, the annual CGT exemption was reduced from £12,300 in the 2022/23 tax year to just £3,000 currently. Additionally, the rates of CGT were increased at the Autumn Budget from 10% to 18% (lower rate) and from 20% to 24% (for higher and additional rate taxpayers).

The forgotten allowance

The annual CGT exemption is often referred to as ‘the forgotten allowance’ among tax experts because it frequently remains unutilised, even among experienced investors. Many people let their exemption expire each tax year end.

One probable reason behind this is that the timing of capital gains tax is often a matter of choice, and most people don’t want to sell successful investments or deal with CGT issues on their tax return until they really have to. Unfortunately, this means that ‘pregnant gains’ can build up on investments that appreciate over time, leading to a higher tax liability down the line.

The annual CGT exemption is ‘use it or lose it,’ and very often for people sitting on long-term gains, it can be advisable to chip away at their tax liability by realising some profits each year. This way, they are not landed with one big tax bill when they come to sell the whole holding at once, with only one year’s CGT exemption available to set their profits against.

Now that the CGT exemption is a meagre £3,000 a year, and the tax rates have increased to 18% and 24%, it’s more important than ever for some investors to consider seeking a bit of tax relief each year by realising a portion of their gains. Even though the tax year end is fast approaching, there is still time to take action on this.

1. Protecting against CGT by sheltering investments

Because the CGT exemption has been slashed to £3,000, if we assume an annual investment return of 5%, this means that investors in direct holdings could now be exposed to a CGT liability on portfolios valued at £60,000 or more. Previously, with the £12,300 exemption, the portfolio would have needed to exceed £246,000.

To manage this reduction in the CGT allowance, you may want to consider using your annual ISA allowance of £20,000, as gains within these accounts are tax-free. If you have any ISA allowance available, it is possible to sell investments and repurchase them in an ISA, although this could necessitate using up some or all of your annual CGT exemption. Investors wishing to benefit from this so-called ‘Bed & ISA’ process will need to act quickly to use this year’s allowances.

It's also important to consider your pension allowances, as investments held within a pension are free of capital gains tax, although there are age restrictions when you can access your pension, and only 25% of the value can be withdrawn tax-free.

Other products to consider include investment bonds (onshore and offshore), as you can buy and sell funds within these tax wrappers without any capital gains being realised, with gains only payable when capital is withdrawn.

A further consideration would be to invest in a fund-of-funds rather than a portfolio of direct funds, as changes within a fund structure don’t realise capital gains, and you can control how much to withdraw from the fund-of-funds to try and remain within the CGT allowance. In contrast, if you invest in direct funds, every time you make a switch or trade, capital gains or losses will be realised.

Please note that all of the investments outlined here do carry risk and you could get back less than your original investment.

Other assets

Don’t forget that it is not just your investments that will be subject to CGT. CGT is also payable on other assets, such as second homes, buy-to-let properties, or holiday lets. Therefore, if you are going to sell a property during a tax year, consider not selling investments that would also realise gains during that same tax year, or sell those that would realise a capital loss to reduce the amount of CGT payable on the sale of the property.

2. Reduce CGT by using your annual exemption

By understanding and utilizing these strategies, you can better manage your capital gains tax liabilities and make the most of your annual exemptions before the end of the current tax year.

Many people amass portfolios of funds, investment trusts, shares, and/or investment properties outside of ISAs and pensions, all of which are assessable to CGT. However, assets only become assessable to CGT when a disposal event occurs, such as the sale of the asset or its transfer to anyone other than your husband, wife or civil partner

Unless a disposal takes place, the annual allowance is never called upon, nor can it be carried forward to future years – so it effectively becomes a valuable benefit lost. As a result, many investors are hit with sizeable tax liabilities when they eventually come to sell or transfer long-held assets to children.

With careful planning, part of a portfolio could be sold to fully utilise the annual CGT allowance – whether or not the investments are then repurchased. If they are repurchased, the base cost used in the CGT calculation will essentially be reset to a new higher level, thereby reducing potential CGT liabilities in the future.

If an investor were to use their CGT exemption each year, then a portfolio of £100,000 achieving a net growth rate of 3% per annum over 20 years could be valued at £175,000 at the end of the term, with a capital gain of only £15,000. On the other hand, an investor in the same scenario who chooses not to utilize their CGT allowance each year would have a capital gain of £75,000 on encashment.

CGT is currently chargeable at 18% for gains falling within a person’s available basic rate income tax band and 24% for higher rate and additional rate taxpayers. This is in comparison to income tax at 20%, 40%, or even 45%. Investments subject to CGT rather than income tax are therefore attractive for people with no personal income tax allowance remaining, even ignoring the use of the aforementioned annual exemption.

For those wishing to crystallise a gain but remain invested in the same asset, the proceeds must not be reinvested before a period of 30 days has elapsed, which may mean being out of the market. They could immediately reinvest into an alternative asset, but this may not always be appropriate.

3. Interspousal transfers

You can transfer assets to other people, but if the transfer is to someone other than your husband, wife or civil partner, this will be a disposal for CGT purposes. The ability for spouses to transfer assets between them is a very useful part of planning around CGT, as it means that you can double up on the £3,000 allowances and, where a gain will still result in tax being paid, transferring assets to a basic rate taxpayer could result in a reduction in tax.

Let’s look at an example:

A higher rate taxpaying individual has a portfolio of shares that they wish to sell, and this will realise a capital gain of £20,000.

If they sell the shares in their own name, they will be able to claim their annual CGT allowance of £3,000, with a taxable gain of £17,000 resulting.

As a higher rate taxpayer, they will pay 24% tax on this gain, which would be £4,080.

If the same individual had a husband, wife or civil partner that was a basic rate taxpayer, they could do the following:

• Transfer half of the shares to the other party prior to sale
• Once sold, a capital gain of £20,000 is still realised, but it is split £10,000 to each of them
• They can both claim £3,000 CGT allowances, meaning their taxable gains are £7,000 each
• The higher rate taxpayer would pay £1,680 on their gain, with the basic rate taxpayer paying £1,260
• The combined tax payable would be £2,940, which represents a tax saving of £1,140 if the higher rate taxpaying spouse sold the assets
• If the spouse transferred all the assets to the basic rate taxpaying spouse, they would realise a gain of £17,000 and the total tax payable would be £3,060

Therefore, with careful planning, it is possible to reduce the overall amount of tax payable on capital gains.

4. Previous capital losses

If you sell assets that result in a capital loss, you are able to carry these forward for an indefinite period of time and use them to reduce the tax that could be payable during periods when you sell assets that have increased in value.

For example:

An investor sold some of their funds during 2022, when the value of the portfolio had fallen, and this resulted in a £5,000 capital loss.

The same investor is looking to release some capital from their investment portfolio before the end of the current tax year. They have calculated that a gain of £10,000 will result from the withdrawal.

They realise the capital gain of £10,000 and can claim their annual CGT allowance of £3,000, as well as using the loss of £5,000 from 2022, meaning that they would only pay CGT on £2,000.

In order to use previous losses, this must be recorded with HMRC, and that means you need to disclose losses on your annual tax return.