Capital Gains Tax: What It Is, How It Works, Rates, Calculations, and Examples

Taxes on capital gains are an essential part of budgeting and managing investments because they significantly affect the returns on such investments.

The guide aims to explain the intricacies of capital gains tax, delineating its definition, operational mechanisms, applicable rates, calculation methodologies, and illustrative examples. Understanding these facets is imperative for investors seeking to navigate the complexities of taxation in the United Kingdom.

The computation of capital gains tax entails a straightforward formula, deducting the adjusted basis of an asset from its selling price. The adjusted basis encompasses the acquisition cost of the asset, transaction expenses, and pertinent adjustments such as enhancements. The resulting capital gain is subject to the prevailing tax rate on capital gains, which varies contingent on factors such as the duration of asset possession and the taxpayer's income bracket.

Consider an individual, for example, who procures a property for £200,000 and subsequently divests it five years later for £300,000. The property's adjusted basis, comprising the purchase price and ancillary transaction outlays, amounts to £205,000. The accrued capital gain totals £95,000 (£300,000 - £205,000). Assuming the individual falls within the 20% tax bracket for long-term capital gains, they incur a capital gains tax liability of £19,000 (£95,000 × 20%).

Comprehending the nuances of capital gains tax, encompassing its rates and methodologies, is indispensable for investors in formulating prudent investment approaches and financial plans.

What are Capital Gains?

The term "capital gains" describes the financial benefits one receives upon selling various assets, including real estate, household goods, and investments such as stocks and bonds. Capital gain or loss is the profit or loss resulting from the sale of an asset. It refers to the sum that deviates from the initial investment in the asset. There is a tax on capital gains, and the rate differs for short-term and long-term gains depending on how long an asset is kept.

Subtract the asset's adjusted basis (purchasing price plus related expenses) from its selling price to find its capital gains. The net amount represents a profit or loss in capital. For example, if someone were to invest £1,000 in stock and then sell it for £1,500, they are going to make £500 in capital gains (£1,500 -£1,000).

A person's taxable income from capital gains directly correlates to when they kept the asset. Assets held for one year or less, referred to as short-term profits, are subject to the ordinary income tax rate. Gains from assets kept for more than a year are subject to a lower tax rate than regular income.

Most net capital gains were subject to a 15% tax rate as of 2020, with variations based on variables including income. Net capital gains are the remaining funds after subtracting capital losses from total gains. The number of days between the asset's acquisition date and its liquidation date is the formula for determining the gain, whether it's short-term or long-term. The capital gains tax is part of a broader category of taxes. Capital gains tax is categorised under the wider classification of types of taxes.

Capital Gains

What is Capital Gains Tax?

Capital gains tax is a way to show how much money a person makes when they sell their assets. The money they make from selling these things is taxed. The rates are based on brackets for long-term gains. The rates for short-term gains are the same as for regular income. Capital gains are taxed so that the government is able to generate funds. The tax system is fair by treating investment income as earning income.

Capital gains taxes are only charged when investments are sold. Unrealised gains and income taxes, on the other hand, are charged on earnings as they come in. It means that people are taxed on the profit they make when selling things. Some investments, such as collectables and owner-occupied real estate, have different rules and things to consider. Tax rates do not apply to these types of investments.

Investors use various tactics to keep capital gains taxes as low as possible. For example, people hold on to investments for more than a year to get lower long-term capital gains tax rates. Capital losses are used to offset gains by investors, lowering their total tax bill. Another way is to use tax-advantaged accounts, such as 401(k)s or IRAs, which delay or avoid paying taxes.

Investors need to keep good records, determine the correct cost basis of their assets, and know the tax effects before they sell them. It means considering how long they keep the money, the applicable tax rates, and any available deductions or breaks. Investors must carefully manage their investments and tax planning techniques to get the best financial results while following tax laws.

Capital gains taxes are a big part of how the economy works because they affect investment choices and encourage people to save money and start businesses. Politicians argue about the right amount of capital gains tax rates, balancing the need to generate cash from tax revenue and encouraging companies to grow and invest.

What is Capital Gains Tax?

How does Capital Gains Tax Work?

The capital gain taxes work as listed below.

  • Determination of Gain: Determining gain involves calculating the difference between an asset's selling price and its adjusted basis. The adjusted basis includes the original purchase price of the asset, any improvements made to it, and certain other costs associated with acquiring and maintaining the asset. The formula to determine the gain Capital Gains Tax (CGT) is Gain = Sale Proceeds - Cost Basis. A gain of £500 results from selling an investment that the person bought for £1,000 and sold for £1,500.
  • Classification of Gains: Gains are either short-term or long-term, depending on the asset's holding period. Assets held for one year or less are considered short-term, while assets held for more than one year are considered long-term. Short-term gains happen after they keep stock for 11 months and sell it. The gain is classified as long-term if they have had the same stock for 15 months before selling.
  • Tax Rates: Tax rates on capital gains vary based on the classification of gains and the taxpayer's income tax bracket. Long-term capital gains are taxed less than short-term gains. The government sets the tax rates for capital gains, which change over time. The standard formula for calculating the tax on gains in Capital Gains Tax (CGT) is Capital Gain×Applicable Tax Rate. Long-term capital gains tax rates for most people range from 0% to 20% as of 2024. Short-term gains are taxed at as high as 37% at ordinary income tax rates.
  • Exemptions and Deductions: Certain exemptions and deductions apply to reduce the amount of capital gains subject to taxation. It includes exclusions for gains on the sale of a primary residence, deductions for capital losses, and other special provisions outlined in the tax code. Individuals in the US are able to deduct up to £250,000 of capital gains from the sale of their primary residence (£500,000 for married couples filing jointly) as long as they meet specific requirements about ownership and use.
  • Reporting and Payment: Taxpayers must report capital gains and losses on their tax returns using Schedule D of Form 1040. They must accurately calculate their profits and losses and report them to the tax authorities. Payment of capital gains tax is made at the time of filing taxes. Capital gains from selling stocks during the tax year must be reported on Schedule D of the tax return, and the tax liability must be calculated based on these gains.
  • Withholding: The tax authorities impose withholding requirements in certain instances, particularly for substantial transactions involving non-resident taxpayers or specific asset types. Withholding ensures that taxes are collected upfront on the proceeds from the sale of assets, reducing the risk of tax evasion. Non-residents who sell real estate must pay withholding tax on the sale proceeds in some nations, which the buyer or a withholding agent withholds and remits to the tax authorities.

Sold real estate is subject to capital gain tax. The tax rules vary depending on whether the home is considered residential or non-residential and the individual's tax status. Gains from residential property are taxed at different rates than gains from other assets. It is common to avoid paying taxes on the gain when the person sells their home. The tax rate to be paid depends on the person’s income tax rate.

Does Capital Gains Tax apply to sold real estate after being purchased with a Bridging Loan?

Yes, capital gains tax (CGT) applies to real estate sold after being purchased with a bridging loan, and the determination of whether it applies hinges on several factors. One crucial consideration is the nature of the property being sold. CGT is applicable if the property sold was not the seller's primary residence, regardless of whether a bridging loan was utilised for its acquisition. Any gains from selling such property are subject to taxation under the CGT regime.

The tax implications become more nuanced when the property sold is the seller's primary residence. In such cases, the seller is eligible for private residence relief, which exempts them from paying CGT on any gains from selling their primary home. The relief significantly mitigates the tax burden of selling a property that served as the seller's primary residence.

Stamp Duty Land Tax (SDLT) is just one of many factors to think about when negotiating a real estate deal with bridging loans and numerous properties. The government imposes a tax on real estate purchases called SDLT. Higher rates are applicable if they buy more than one property at once. There are scenarios where a refund for the higher SDLT rates paid is claimed, such as selling the old property within a specified timeframe after purchasing the new one.

What is the rate of Capital Gains Tax in 2024/25 in the UK?

The rate of capital gains tax in 2024/25 in the UK is 10% to 28%. The imposed charge is based on one's earnings and property sold. People are granted a capital gains tax allowance of £3,000, meaning that the first £3,000 of their total capital gains is tax-free. Any gains exceeding the allowance are subject to taxation.

Calculating capital gains tax involves applying distinct tax rates based on the individual's earnings and capital gains from selling assets. Basic-rate taxpayers pay less on capital gains than higher-rate taxpayers. The tax rates differ depending on the sort of asset sold, with different rates applicable for assets such as shares, residential property, and other investments.

One must determine their total capital gains to calculate the tax owed on capital gains by subtracting the annual exempt amount (£3,000) and applying the relevant tax rates to the left-over taxable gains. The tax rates range from 0% to 20%, based on a person's earnings level and the nature of the asset sold. For example, basic-rate taxpayers pay 10% on certain gains, while higher-rate taxpayers pay 20%.

Consider allowable losses, which are reported to HMRC for potential tax relief. Appropriate losses from trading possessions make up for capital gains, lowering the tax burden. Specific conditions apply to claim permissible losses.

How is Capital Gains Tax Calculated?

Capital gains tax is calculated using the 7 steps listed below.

  • Determine the Sale Price. The sale price is the amount received from selling the asset.
  • Calculate the Adjusted Basis. The adjusted basis is the asset's original purchase price, adjusted for any improvements, depreciation, or transaction costs incurred during ownership. The formula to calculate the adjusted basis is Original Cost Basis + Capital Improvements - Depreciation - Adjustments.
  • Calculate the Capital Gain. The capital gain is determined by subtracting the adjusted basis from the sale price. The formula to get Capital Gain is Sale Price - Adjusted Basis
  • Determine the Holding Period. The holding period is the time the asset was held before being sold. Different tax rates apply based on whether the asset was held for a short-term or long-term period.
  • Apply the Appropriate Tax Rate. Capital Gains Tax rates vary depending on the type of asset being sold, such as residential property or other assets, and the taxpayer's income tax bracket. For example, gains from residential property are subject to higher rates, with 28% for higher-rate taxpayers and 20% for gains from other chargeable assets.
  • Consider Exemptions and Deductions. Tax-free allowances and deductions apply, reducing the taxable capital gains. For example, individuals have an annual tax-free allowance of £12,300 (as of 2022/2023) deducted from their total gains.
  • Calculate the Tax Owed. The tax owed is calculated by applying the applicable tax rate to the taxable capital gains after considering any exemptions and deductions. The formula to calculate Tax Owed is Taxable Capital Gains x Applicable Tax Rate.

Suppose an individual sells a piece of art for £50,000. They originally purchased the artwork for £30,000 and incurred £2,000 in transaction costs. The holding period for the artwork was 5 years. Adjusted Basis = Purchase Price + Transaction Costs = £30,000 + £2,000 = £32,000. Capital Gain = Sale Price - Adjusted Basis = £50,000 - £32,000 = £18,000. The person pays 10% in taxes on the £18,000 capital gain if they are a basic rate taxpayer by income tax bracket, thus having a Tax Owed of £18,000 x 0.10 = £1,800.

What are the examples of Capital Gains Tax?

Examples of capital gains tax are listed below.

  • Stocks and Bonds: Stocks represent ownership in a company, while bonds are debt securities issued by governments or corporations. A person's capital gain is found by taking the selling price minus the price they bought the security at (cost basis). Capital Gain = Selling Price - Purchase Price. The capital gain is £500 if they purchased stocks for £1,000 and sold them for £1,500.
  • Real Estate: Real estate includes residential homes, commercial buildings, land, and rental properties. Capital gains tax is applied when real estate is sold for a profit. The gain is calculated by subtracting the adjusted basis (purchase price plus acquisition costs and improvements) from the selling price. The calculation formula is Capital Gain = Selling Price - Adjusted Basis. The capital gain is £80,000 if they bought a house for £200,000, spent £20,000 on renovations, and sold it for £300,000.
  • Mutual Funds: Mutual funds pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities. Capital gains tax is triggered when mutual fund shares are sold at a profit. The gain is calculated based on the difference between the selling and purchase prices per share. The calculation formula is Capital Gain = (Selling Price per Share - Purchase Price per Share) x Number of Shares Sold. The capital gain is £2,000 if they bought mutual fund shares for £50 each and sold them for £70 each, realising a gain on 100 shares.
  • Collectibles: Collectibles include items such as artwork, antiques, coins, stamps, and precious metals. Capital gains tax applies to the sale of collectables at a profit. The gain is calculated similarly to other assets by subtracting the purchase price from the selling price. The formula is Capital Gain = Selling Price - Purchase Price. The capital gain is £5,000 if they purchase a piece of artwork for £10,000 and sell it for £15,000.
  • Cryptocurrency: Cryptocurrency is a digital or virtual currency that uses cryptography for security and operates on decentralised networks. A capital gains tax is applied when cryptocurrencies are sold for a profit. The gain is calculated based on the difference between the cryptocurrency's selling price and purchase price. The calculation formula is Capital Gain = Selling Price - Purchase Price. The capital gain is £5,000 if they bought Bitcoin for £5,000 and sold it for £10,000.
  • Business Assets: Business assets include equipment, machinery, vehicles, intellectual property, and goodwill owned by a business. Capital gains tax applies when business assets are sold for a profit. The gain is calculated similarly to other assets by subtracting the adjusted basis from the selling price. The calculation formula is Capital Gain = Selling Price - Adjusted Basis. For example, the capital gain is £5,000 if a business sells a piece of equipment for £20,000, and its adjusted basis is £15,000.

When do you pay Capital Gains Tax?

You pay Capital Gains Tax when you sell an asset that has increased in value and make more money that exceeds the tax-free allowance within 30 days. Capital gains tax applies to assets such as property, shares not held in an ISA or pension, and valuable items such as antiques, art, and business assets. The timing of when the person pays Capital Gains Tax depends on several factors.

There are reporting requirements, as taxable gains must be reported on a person’s tax return, and they must pay the tax owed accordingly. A person must register with HMRC before they are allowed to file their tax return if they have not done so before. The deadline for payment is crucial. The time allowed to pay the first instalment of Capital Gains Tax after selling a property has been reduced to 30 days. Reporting deadlines vary, but one must report gains by specific dates, such as December 31.

A person has the option to report gains using the "real-time" Capital Gains Tax service or through the self-assessment tax return system. No matter which method the person chooses, one must ensure they have correct calculations for each gain or loss and information about any tax breaks they are eligible for, including how much each asset costs and how much they receive. Paying the Capital Gains Tax by the deadline is crucial, as is ensuring they have sufficient time to complete the reporting process accurately. Failure to pay on time results in penalties and interest charges.

Various strategies help minimise Capital Gains Tax liability. It includes spreading disposals over tax years, deducting allowable costs related to the property, utilising available reliefs, and investing in tax-efficient accounts such as ISAs and pensions. Taxpayers pay Capital Gains Tax when they sell assets at a profit exceeding the tax-free allowance, and adherence to proper reporting and payment procedures is essential to comply with tax regulations and avoid penalties.

What are Long-Term Capital Gains?

Long-term capital gains in the UK are the money made after selling assets one has had for over a year. Individuals receive long-term capital gains when they sell assets they have owned for a long time.

Assets must be held for more than one year before they are sold in the UK to get long-term capital gains tax treatment. A short-term capital gain is when an asset is sold after being owned for less than a year.

A person's income and marital status determine the tax rate applied to long-term capital gains in the United Kingdom. Long-term capital gains tax rates in the UK are anywhere from 0% to 25% in 2023. HM Revenue & Customs states that the exact rate is based on income levels and filing status.

Consider an individual named Sarah who bought shares in a company in April 2021, for example, and sold them in May 2023. Sarah must pay taxes at 15% on her capital gains if she falls into the tax bracket that levies that rate on long-term capital gains. Sarah owes £1,500 in taxes (15% of £10,000), assuming Sarah made £10,000 as a capital gain by selling shares.

What are Short-Term Capital Gains?

Short-term capital gains in the United Kingdom are earnings derived from the disposal of a capital asset held for one year or less. The gains are considered short-term because the assets were held for a short time.

The asset is only eligible for a short-term capital gain in the UK if sold within a year of purchase. Long-term capital gains are from selling an asset held for over a year.

Individuals in the UK are taxed on their short-term capital gains as regular income, depending on how they file their taxes and how much money they make overall. People have different tax rates for short-term capital gains based on their salary and how they file their taxes.

A person makes a short-term cash gain when they buy shares of a company in January and sell them for a profit in November of the same year. The short-term capital gains tax rate must be applied to the gains based on the person's salary and filing status.

What is the difference between Long-Term Capital Gains compared to Short-Term Capital Gains?

Differences between Long-Term Capital Gains and Short-Term Capital Gains are listed below.

  • Definition: Long-term and short-term capital gains represent distinct revenues derived when assets are liquidated, each impacted by unique tax guidelines and factors. Capital gains held for more than one year are called long-term gains. Gains from assets held for less than a year are short-term capital gains. One key difference is the holding period before selling the assets.
  • Tax Treatment: Tax treatment is another crucial distinction between long-term and short-term capital gains. Rates of reduced long-term capital gains taxation vary from 0% to 20%, depending on the taxpayer's income. The opposite is true for short-term capital gains, which are subject to ordinary income tax rates ranging from 10% to 37% based on a person's income and filing status. The variance in tax treatment underscores the importance of understanding the holding period of assets and its implications for paying taxes.
  • Holding Period: The holding period is fundamental in determining whether gains qualify as long-term or short-term. Long-term capital gains necessitate that assets be held for more than one year to enjoy favourable tax treatment. Assets sold within one year are categorised as short-term capital gains, subject to higher tax rates akin to ordinary income.
  • Tax Planning: Tax planning strategies diverge between long-term and short-term capital gains scenarios. Investors employ a buy-and-hold strategy for long-term capital gains, retaining assets for extended periods to capitalise on lower tax rates upon eventual sale. Tax planning for short-term capital gains entails strategic timing of asset sales to minimise tax impact and leveraging offsetting gains with losses to mitigate tax liabilities effectively.
  • Investment Strategy: Investment strategies vary between long-term and short-term capital gains. Long-term capital gains prompt investors to adopt buy-and-hold approaches, focusing on the long-term appreciation of assets to optimise savings on taxes. Short-term capital gains prompt greater activity in trading as investors try to exploit short-term market shifts to capitalise on fast earning opportunities.

Is Capital Gains Tax a Direct Tax or an Indirect Tax?

Capital Gains Tax (CGT) is a direct tax in the United Kingdom. The UK's government charges people and businesses direct taxes based on their taxable earnings, profits, or wealth. CGT falls within the category because it is directly imposed on the profits gained from selling or disposing of valuable items such as property, stocks, bonds, or other investments. Taxpayers must report their capital gains and remit the applicable tax directly to the government.

Indirect taxes are passed on to consumers through the prices of goods and services. Capital gains tax, on the other hand, is paid directly by the people or businesses that make the gains. Its direct assessment and collection from the taxpayer align CGT with the characteristics of a direct tax.

Consumers ultimately pay indirect taxes, such as value-added tax (VAT) or sales tax, on purchases of goods and services. CGT, levied directly on capital gains, does not follow the indirect taxation model but instead requires taxpayers to directly declare and pay the tax on their capital gains to the government.

Capital Gains Tax is considered a direct tax in the UK tax system because it is imposed directly on individuals or entities based on their profits derived from capital asset sales without being passed on to purchasers through the price of products or assistance. The state levies direct and indirect taxes to generate revenue and manage economic activities within the country.

No, you cannot skip the payment of Capital Gains Tax (CGT). The government enforces a compulsory CGT tax on the gains from selling or giving away capital assets. Capital gains must be disclosed to HM Revenue and Customs (HMRC) and are subject to taxation upon acquisition. A legal requirement is whether the person is selling a house or other taxable assets.

Capital Gains Tax (CGT) rates fluctuate based on the taxpayer's income tax band, the nature of the asset sold, and whether the profits are derived from residential or other assets. Higher-rate taxpayers are subject to a 28% tax rate on gains from residential property and a 20% tax rate on earnings from other chargeable assets. Basic-rate taxpayers face a tax rate of either 10% or 20%, which varies based on the magnitude of their gain and taxable income.

Avoiding the payment of Capital Gains Tax is not a choice, as neglecting to record and pay the required tax leads to penalties and legal repercussions. Individuals must record their capital gains accurately with HMRC and pay the relevant tax within the prescribed dates, either as part of the yearly self-assessment tax return or within 30 days of disposing of specific assets, such as a home. Adhere to CGT legislation and meet tax responsibilities to prevent any consequences from HMRC.

Is there a Capital Gains Tax exemption?

Yes, there is a Capital Gains Tax exemption. Individuals, personal representatives, and trustees for handicapped people in the United Kingdom are eligible for an annual tax-free allowance known as the annual exempt amount (AEA) for Capital Gains Tax purposes. The AEA allowance allows taxpayers to offset certain earnings before paying Capital earnings Tax. The annual exempt amount varies by tax year, with separate restrictions for individuals and trustees. For example, for the tax year 2023-2024, the annual exempt amount is £6,000 for individuals and £3,000 for the majority of trustees.

The annual exempt amount is applied to profits from chargeable assets, such as real estate and investments, to decrease the tax owing. Capital Gains Tax is not required if overall gains for the tax year (after losses and reliefs) do not exceed the annual exempt amount.

Certain persons, such as non-domiciled individuals who claim the remittance basis of taxation on their foreign income and earnings, are not eligible for the annual tax-free sum. Different rates and restrictions apply to different types of gains and taxpayers, so it's best to check HM Revenue & Customs (HMRC) guidelines or get professional advice to understand how the exemption relates to the taxpayer's unique situation. 

What are examples of Capital Gains Tax exemptions?

Examples of capital gains tax exemptions are primary residence exclusion, retirement accounts, small gains, specific investments, and gifts or inheritance.

Capital Gains Tax exemptions play a crucial role in the UK tax system, offering relief from taxation on specific gains. One significant exemption is the Primary Residence Exclusion, which shields people from Capital Gains Tax on the profits from the sale of their primary residence. The exemption aims to provide financial stability to homeowners and incentivise property ownership by ensuring that they are not penalised for selling their primary residence. An individual is able to keep a greater portion of the profit they make from selling their primary home because capital gains tax does not apply to such gains.

Retirement accounts, such as Individual Retirement Accounts (IRAs) and workplace pensions, enjoy exemptions from Capital Gains Tax. Contributions to these accounts are tax-deferred, meaning taxes are deferred until funds are withdrawn during retirement. The exemption encourages individuals to save for retirement by offering tax benefits and allowing their investments to grow tax-free until retirement. People are able to save more efficiently as a result of not having to pay taxes on their investment gains right away.

The Small Gains Exemption relieves individuals whose total capital gains for the tax year fall below a certain threshold aligned with the Annual Exempt Amount. The exemption simplifies tax administration by exempting individuals from reporting and paying Capital Gains Tax on gains below the specified threshold. It acknowledges that small gains do not significantly impact an individual's tax liability and aims to streamline tax processes.

Specific investments held within tax-efficient vehicles such as Individual Savings Accounts (ISAs) and government bonds are exempt from Capital Gains Tax. ISAs allow individuals to invest in various assets, including stocks, bonds, and cash, without incurring tax on any income or gains generated within the account. The exemption encourages investment and savings by providing tax-efficient avenues for wealth growth.

Gifts and inheritances are exempt from Capital Gains Tax, recognising that such transfers occur between family members or as part of estate planning. Individuals who acquire assets as gifts or inheritances do not incur capital gains tax liabilities. The exception promotes intergenerational asset transfers and estate planning without increasing recipients' tax costs. Capital Gains Tax exemptions promote financial security, encourage ventures, and simplify tax responsibilities for people and families in the UK.


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