Capital Gains Tax – What you need to know 2018

As an investor, it is essential that you understand what capital gains tax is and what is expected when filing these taxes. Most beginner traders and investors often focus on learning about trading and forget that there are tax requirements that must be observed to be on the right side of the law. The capital gain tax is mandatory in most countries with each country having its criteria for reporting.

In this post, we will cover the general information about capital gain tax and everything you need to know about filing for capital gains in Europe and in the US.

  • Different types of a capital gains tax rate.
  • Who should pay a capital gains tax?
  • How is capital gains tax rate calculated?
  • Tips to minimize capital gains tax.
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What is a Capital gains tax?

A capital gains tax is a tax levied on the income derived from the difference between the buying price and the selling price of an asset. For example, if a trader buys XYZ share at £15 and sells it at £20, the capital gain is £5, which is the amount that is taxed.

The capital gain tax is usually paid at the sale of an asset which means that one does not have to worry about these taxes until they decide to sell their assets. Simply put, an investor can hold an asset that appreciates every month, but they do not owe any capital gains tax until they decide to sell it even if it is after 20 years.

As mentioned in the introduction, different countries have different requirements for the capital gains tax, and therefore it is essential for the investor to understand the criteria followed in their jurisdiction.

For instance, while there are no capital gains taxes in countries like Switzerland and Belgium, it is a requirement in the United States for individuals and corporations to pay annual capital gains taxes on their net capital gains. The same case applies in the UK where both the individuals and corporations are required to file for capital gains annually.

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Different types of capital gains tax

Capital gains taxes can either be long term or short term. The difference between the two is that the former is derived from investments held for more than one year while the latter is for those held below one year.

For instance, if an investor purchases 50 shares of stock for £10 per share and sells them four months later at £13 per share, the capital gains tax to be paid will be short term. Likewise, if the investor holds the shares for eighteen months and sells them at £15 per share, the capital gains tax to be paid will be long term.

The difference between the two is of utmost importance given that they are taxed differently. This is especially for those in the US where short-term capital gains are taxed as ordinary income. In the U.S. individuals are advised to hold on their investments for more than one year to reduce their tax burden.

However, it is important to note that not all tax jurisdictions pay much attention to the period the asset is held and therefore it is good that you engage a tax expert in determining your country requirements. We recommend that you only settle for a tax expert with considerable experience in matters of capital gains tax in trading and investing.

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Who should pay a capital gains tax?

In most countries, individuals and corporations are subject to capital gains taxes. For both, the sale of assets such as stocks, bonds, precious metals, and property must be accompanied by tax reporting on capital gains and payments where applicable.

However, in the UK, individual income that is derived from the day trading of Forex, CFDs and Spread betting is not subject to the capital gains tax. This is because the above investment classes are considered as speculative given that no underlying asset is owned. Under this rule, the day traders may need to pay income tax, but their gains are not subject the capital gains tax.

According to GOV.UK, individuals pay income tax when they sell or ‘dispose of’ their personal belongings or property that isn’t their primary home. However, the sale of your home can be subject to capital gains tax if you have let it out, used it for business or it is very large. The taxable personal possessions are those with a worth of £6000 or more in exception of a personal car.

Also taxable are shares that are not in an Instant Savings Account or Personal Equity Plans and business assets such as patents and registered trademarks. Assets that are not eligible for the capital gains tax include gifts and the gains made from them, ISAs or PEPs, UK government gilts and premium bonds and betting, lottery, or pool winnings.

Calculation of capital gains tax

A capital gains tax is a fraction of the amount gained in the appreciation of an asset. However, the detailed calculation of capital gains tax depends on the tax jurisdiction.

There are numerous online resources to help in the calculation of capital gains tax but for the purpose learning, let us review the formulas applied in the UK. First, to calculate your capital gains tax, you need to calculate the capital gain. As mentioned above, this is derived from the difference between the buying price and the selling price of an asset.

For instance, a trader buys 50 XYZ shares at £20 per share, and after one year, the price has risen to £32 per share. If the trader decides to sell at this point, the total proceeds will be £1600 (50*32) compared to the total buying price of £1000 (50*20). The capital gains will, therefore, be £600 (£1600 – £1000).

Now let’s say that they were filing in the UK. The requirement is to add together the gains from each asset and deduct any allowable losses. The implication is that if share XYZ is held in a portfolio, the investor is required to calculate the aggregate capital gains which include losses within the portfolio. This, in turn, reduces the capital gains tax burden.

The top three most important tips to Minimize Your Capital gains tax rate

Use tax-advantaged accounts.

If you are in the UK, committing your assets to an Individual Saving account (ISA) is one of the best ways to reduce the capital gains tax bill. The assets committed in ISA can be in the form of cash or stocks and shares, or a combination of the two. Each year, the HMRC gives an ISA allowance which sets the maximum amount one can save tax-free within the tax year.

In the financial year 2018/19, one can save up to a maximum of £20,000 in cash or stocks or a combination of both, tax-free. In the US, the IRS provides similar benefits for Individual Retirement Account holders. Use the annual tax-free allowance.

Each year, the UK government provides an annual tax-free allowance known as the Annual Exempt Amount (AEA) to nearly everyone who is liable for Capital Gains Tax. In the US, the IRS provides a similar tax allowance each year especially on the sale of a property.

Keep the records of repairs on personal properties.

If you own a second home that you let and intends to sell it in the future, ensure that you keep records showing all the repairs that you have carried out and their costs. At the sale, the taxman will require you to provide evidence of these expenses to get deductions on the taxable amount.

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These tips can also be very helpful

Gift assets to a spouse.

As mentioned earlier, gifts are exempt from capital gains tax. By transferring your assets to your partner, you take advantage of both capital gains tax allowances amounting to £22,200.

Spread gains over tax years.

Instead of selling your assets at a go and only benefit from the allowances of that year, you can split the amount to sell in two tax years and enjoy the cumulative allowances.

Consider the Bed and ISA/SIPP strategy.

The Bed and ISA strategy allows you to sell existing investments and use the proceeds to top up or open an ISA account. Once on the safety net of this account, you can then use the proceeds to fund a near-identical purchase.

The Bed and SIPP strategy work in similar ways only that it involves selling assets and then repurchasing them under the cover of Self Invested Personal Pension. All proceeds made inside the SIPP are tax-free making it one of the best options to avoid capital gains tax.

It is important to note that your capital gains must be in the range of the specified ISA maximum amount to enjoy the tax-free benefits.  The tax allowances for a given financial year can be accessed from the HMRC website.

Additional Tips for Experienced Traders/Investors

Reduce taxable amount.

Another way to minimize your tax bill on capital gains is to reduce your taxable income. This can be achieved by sacrificing your salary through pension contributions or childcare vouchers or by transferring taxable income bearing assets such as cash deposits to a lower earning spouse. Other ways include deferring the state pension and a change from earning to pension incomes.

Lowering the taxable income in any given financial year has a potential to reduce the capital gains tax rate from 20% to 10% or 28% to 18% for those selling residential property.

Be sure to Invest in small companies first.

The tax bill on capital gains can also be reduced by investing in special-tax efficient programs which provide funding to small businesses. These include Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCTs). However, this option is best left to experienced and rich investors.

It is better to exchange rather than sell.

Another way to reduce your capital gains tax bill is to exchange your asset with another similar asset instead of selling. Exchanging like-kind assets enables you to defer the capital gains tax until you finally sell the asset you received in exchange.

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Conclusion:

Capital Gains Bottom Line

Please note that you do not have to exchange with another person. You can sell your asset and use the proceeds to buy a similar asset within the timeframe allowed by your tax jurisdiction.

Please note that you do not have to exchange with another person. You can sell your asset and use the proceeds to buy a similar asset within the timeframe allowed by your tax jurisdiction.

As we have seen, it is important for traders and investors to understand the capital gains tax concept and take the necessary measures to be taken. The calculation of capital gains tax rate differs with tax jurisdictions, and therefore it is important to engage a tax professional when filing.

As a trader or an investor, there are a number of ways you can reduce your capital gains tax burden. You should be aware of them and explore the suitable ones to maximize profits. Subscribe for more information about taxes and tips to help you lower your tax burden.

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