No matter how you make your money, you just know the taxman will always grab his slice. If you're selling assets, the penalty you need to beware of is capital gains tax.
If you're likely to be hit with capital gains tax - or CGT - this tax year, it's worth knowing a fair bit about how it works. Better still, it's a great idea to learn how to avoid it.
But let's start with a gander at the basics. Then we'll find out about a couple of tricks for mitigating your liability.
CGT - the basics
CGT applies to the gains you make when you sell or dispose of an asset by exchanging or transferring it, or gifting it away to someone who isn't your spouse. Assets which could be subject to CGT include everything from stocks & shares to valuable jewellery to property that isn't your main residence.
Big changes took place to CGT rates back in April 2008. At that time any amount chargeable to CGT was added on top of your income and payable at a rate of 10%, 20% or 40% depending on your tax bracket. This has since been replaced with one simple flat rate of 18%.
But not all your gains will automatically trigger a CGT charge. Everyone is entitled to a CGT-free allowance which is usually up-rated every tax year. The allowance is currently £10,100 which means only gains above this amount are subject to CGT.
The annual allowance effectively provides a tax-free return up to £10,100. If you don't use it up you won't able to carry it over to the following year. The idea is you limit the amount of CGT payable by only realising gains up to the value of the allowance each tax year.
Remember any capital losses you make can be used to offset your capital gains, and reduce your CGT bill.
Cut your tax bill
The CGT allowance is per person, so it may be a good idea to hold assets jointly with your spouse, allowing you to realise a profit of up to £20,200 before a CGT charge is triggered.
If you own an asset solely where the profits on sale would exceed the allowance, you could gift half of the asset to your spouse, and then use each of your allowances to reduce the amount of CGT payable.
The bed and breakfast loophole
At one time it was possible to play the system by 'bed and breakfasting'. This involved selling an asset, such as shares or an investment fund, on the last day of the tax year to realise a gain up to the value of the CGT-free allowance, and then repurchasing it the following day. This enabled investors to retain ownership of the asset, but its purchase price would be raised on repurchasing so that the CGT liability when it was ultimately disposed of would be reduced.
This process may sound risky but the chances of the market moving significantly against the investor overnight were pretty minimal. Bed and breakfasting was also be used to create capital losses which could be offset against other gains made in the tax year.
The bed and ISA trick
Not surprisingly, the bed and breakfast loophole was closed back in 1998. Now investors selling shares, or other investments, must wait 30 days before repurchasing otherwise the sale of assets won't be recognised from a tax perspective.
But that doesn't mean there aren't other ways you can reduce your CGT bill. You could try 'bed and ISA', for example, where you sell the assets on the last day of the tax year and then repurchase them the following day within an ISA wrapper. The 30 day waiting rule doesn't apply when the assets are bought in this way. But you are restricted by the limits of the ISA allowance.
Similarly, you can make the most of your CGT exemption by selling assets and realising a gain up to the value of the allowance. Then, to get around the 30 day waiting rule, your spouse purchases an identical investment and transfers it back to you without creating a capital gain or loss for either of you.
Again this is just another way of realising a tax-free gain, and raising the purchase price of your assets to reduce your CGT liability later on.
CGT-free investments for everyday investors
If all this tax juggling seems a bit more trouble than it's worth, don't forget everyday investors can easily shelter investments from CGT by using their ISA allowance every year. Even if the value of your ISA rockets into the stratosphere, when you come to sell up there won't be any CGT to pay. It's looking like CGT rates could rise in the future, which means it's a good idea to invest as much as you can in ISAs to protect your gains from tax.
You can invest up to £7,200 in ISAs before the end of the tax year deadline on April 5. If you're over fifty, you're entitled to a more generous contribution limit of £10,100. Everyone will be entitled to the higher allowance when the new tax year starts on April 6.
Get help from lovemoney.com
If you're new to investing, there are plenty of things lovemoney.com can help you with.
First off, why not check out some of the hints and tips in our goal: Make money from the stock market
Next, have a look at this video: How to invest your first stocks and shares ISA
And finally, if you have any questions about investing or tax, why not see if the lovemoney.com community can help at Q&A.