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Capital Gains: Understanding the Basics

VIDEO: An explanation of the ins and outs of capital gains and what it all means for your taxes

Alanna Petroff 25 February, 2013 | 11:04AM

Video Transcript:

Alanna Petroff: The term ‘capital gains’ seems like both a good and bad thing. On the one hand it's a good thing, because if you've made capital gains then it means that you've made money on investment. But on the other hand when you think about capital gains you immediately start thinking about the taxes you'll have to pay on those capital gains. Joining me now to talk about these issues is Pete Matthew, from Jacksons Wealth Management. He's the managing director there.

Pete, thanks very much for coming in.

Pete Matthew: Hey Alanna, great to be here.

Petroff: Okay. So let's go over capital gains, give me a brief definition to start and then we’ll get into the nitty-gritties.

Matthew: Okay. The briefest and most simple definition is the difference between what you sell something for, the amount you sell it for and the amount you paid for it. So, the difference in the selling price and the buying price. That's the most simple straight-forward definition.

Petroff: And you can make capital gains off of equities and properties. What else can you make capital gains on?

Matthew: Yeah. Okay, yes shares like you said, equities, funds which hold equities, property definitely, not your primary residence though not the house that you live in or you're deemed to be living in. There are some other things that you can't--that you don't pay capital gains tax on, should I mention those as well?

Petroff: Yes.

Matthew: Gilts is an important one, particularly for investors, so if you directly hold UK government gilts, then when you sell them they're capital gains exempt. So, it's a useful exemption. Obvious things like national savings, premium bonds, your primary residence as I said; those things are exempt from capital gains.

Petroff: And how does capital gains taxes, how does that all work? Let's go over it in the most simple manner possible.

Matthew: No problem. Okay, so when working out of the gain, one thing that's important to know is that any costs you have incurred in making the gain can be taken off. So, a good example is if you have a second property, a rental property for example, so you buy that for one price and you sell it for a higher price, if along the way you have perhaps done some maintenance on the property then the cost of that maintenance can be taken off your gain. So that's quite a useful little sort of relief there.

Once you've worked out what the gain is, the next thing to say really is that everybody gets an annual capital gains allowance, currently in the 2012/13 tax year that's £10,600. So, if you make a gain which is below that, then you have no tax to pay.

Petroff: So, I can make a gain of 10,000 pounds and not pay any tax at all on that capital gain?

Matthew: Correct.

Petroff: Amazing. But then what happen once you go over that £10,600?

Matthew:  Okay. So, if your gain is in excess of £10,600, how it's worked out is the amount of the taxable gain is added to your income in the current year. Now, if depending on what your income is, of course, but when the gain is added to the income if the total is below the higher rate tax threshold then the gain is taxed at 18%. If the gain when added to your income takes you into the higher rate band then the amount of the gain below the threshold will be at 18%, but above the threshold will be at 28%. So it's added to your income and that determines the rate that you pay on the different bits.

Petroff: Now, let's talk about any way to defer. Is there a way to defer capital gains tax?

Matthew: Yes, defer but not get out of entirely. There are a couple of ways you can defer capital gains tax, it's fairly technical stuff, so it's definitely worth seeing a competent adviser about that, but there are schemes for example which will help you defer until some point in the future. So I'm thinking particularly of enterprise investment schemes, and there are various reasons why those might be a good or bad idea, but for capital gains tax purposes, you can defer payment of the gain until a time when it might be more tax efficient for you do that.

Petroff: Okay. And what about offsetting gains with losses? We've all made some losses here and there in our investments. So, what happens there?

Matthew: Sure. Well it's quite simple, you can offset any losses you make against the gains you make. So, if you made a £20,000 gain and £5,000 loss, then your net taxable gain would be £15,000. And you can carry forward those losses quite a long time, it doesn't have to be just that you've made a loss and a gain in the same tax year. You can carry forward those losses for--technical point--five years and 10 months from the end of the tax year when you made the loss. So, you can bring forward those losses quite a long time. So worth keeping good records.

Petroff: Yeah, that seems rather generous of the government, I suppose.

Matthew: Unusually.

Petroff: Yeah, unusually generous. Okay, thank you very much for coming in today.

Matthew: You're welcome.

Petroff: That was Pete Matthew. He's the managing director at Jacksons Wealth Management. I'm Alanna Petroff. Thanks for watching Morningstar.

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About Author Alanna Petroff

Alanna Petroff  is a financial journalist with Morningstar UK.