Tax. It can be a confusing topic nobody much likes getting to grips with. But, like it or not, understanding taxes is crucial for managing our financial affairs effectively. One area of taxation that often raises eyebrows is Capital Gains Tax. Does it leave you scratching your head? Then it’s time to gain a better understanding.
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What Is Capital Gains Tax?
Essentially, Capital Gains Tax is levied on the profit gained from the sale of an asset that has increased in value.
For example, if you acquire an asset for £5,000 and subsequently sell it, or ‘dispose of’ it, for £20,000, you have made a gain of £15,000. Disposing of an asset can mean anything from selling it, giving it away as a gift, swapping it, or getting compensation for it – such as in an insurance settlement.
After disposing of an asset, wouldn’t it be ideal to keep all of the subsequent gain, or profit? While certain assets enjoy tax-exempt status, you may find yourself liable to pay Capital Gains Tax on such gains.
How Does Capital Gains Tax Work?
When thinking about how Capital Gains Tax operates, the first thing it is essential to clarify is what it applies to.
Under UK government regulations, Capital Gains Tax is applicable when you sell or dispose of the following:
- Personal possessions worth £6,000 or more, excluding your car
- Property that is not your primary residence
- Your primary residence if it has been let out, used for business, or is exceptionally large.
- Any shares not held within an ISA or PEP
- Business assets
These items are categorised as ‘chargeable assets’, and Capital Gains Tax is levied upon them. This applies even if you dispose of an asset jointly owned with another individual – in this case, you’re responsible for paying Capital Gains Tax on your portion of the gain.
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What Is The Rate Of Capital Gains Tax?
The rate of Capital Gains Tax varies depending on your tax bracket. As of 2024, higher or additional rate taxpayers incur a 28% tax on gains from residential property and 20% on gains from other chargeable assets.
For basic rate taxpayers, the rate applicable hinges on the size of your gain, taxable income, and whether the gain stems from residential property or other assets. To calculate this, determine your taxable income and total taxable gains. Subtract your tax-free allowance from the total taxable gains. Then, add this figure to your taxable income.
If the resulting amount falls within the basic Income Tax band, you’ll face a 10% tax rate on gains (or 18% on residential property). Any amount exceeding the basic tax rate incurs a 20% tax rate (or 28% on residential property).
Finally, if you’re a trustee or personal representative of someone who’s died, you’ll pay 28% on residential property and 20% on other chargeable assets.
When Don’t You Pay Capital Gains Tax?
As noted, specific assets are exempt from taxation. This exemption includes gains from ISAs, PEPs, UK government gilts, and Premium Bonds, as well as betting, lottery, or pool winnings. Capital Gains Tax does not apply to gains falling below the annual tax-free allowance. In 2024, this allowance sits at £6,000 for individuals or £3,000 for trusts.
Additionally, transfers of assets to your spouse, civil partner, or a charity typically do not incur Capital Gains Tax.
How Does HMRC Know About Capital Gains?
It would be easy for one to think: How does the HMRC track Capital Gains Tax? After all, assets are surely sold or disposed of all the time. Furthermore, what are the consequences of non-payment?
Especially in significant transactions like property sales, be assured that the HMRC becomes aware through various channels such as land registry records, advertisements, changes in rental income reporting, or Stamp Duty Land tax returns.
Even in smaller transactions, HMRC can detect asset sales or disposals through means like bank transfers among other ways.
In summary, it’s safe to say the HMRC stays informed about asset disposals subject to Capital Gains Tax.
Failure to pay Capital Gains Tax results in subsequent liabilities. You have a 60-day window from the completion date to report and settle the tax, or else face penalties and interest. Thus, it’s crucial to avoid such situations.
If navigating your tax obligations proves challenging, seeking assistance from an accountant or directly contacting HMRC is advisable.
