The difference between trading and making a capital gain is important because the rates of tax you pay are different.
What is Capital Gains Tax?
Capital Gains Tax (CGT) is a tax on the profit made when you sell or “dispose” * of an asset that has increased in value. The tax is applied to the gain, not the total amount received from the sale. Certain assets are exempt from CGT, and you don't pay CGT if your annual gains are below the tax-free allowance.
* "Disposing of" is an HMRC term for selling, gifting, swapping, or receiving compensation for an asset.
Trading vs. owning an asset
The way you intend to use the item you purchase determines whether you are trading or holding it as an investment. For example:
- Renting then selling: Buying a house, renting it for several years, and then selling it for a profit means you will pay CGT on the gain.
- Improving then selling: Buying a house to renovate and sell at a profit is viewed by HMRC as a trade, and you will be charged income tax and possibly national insurance on the profit.
Understanding the difference between trading and making a capital gain is important because the tax rates differ.
What you pay CGT on
You pay CGT on gains from:
- Most personal possessions worth over £6,000 (excluding cars)
- Property that is not your main home
- Your main home if it has been rented out or used for a business
- Shares not in an ISA or PEP
- Business assets
If the asset is jointly owned, you pay CGT on your share of the gain. Certain reliefs may reduce your tax.
Ways we can help reduce your CGT liability
- Use Your CGT exemption: Make full use of your annual CGT exemption to reduce your CGT liability.
- Transfer assets to your spouse or civil partner: Transfers between spouses and civil partners are exempt from CGT, effectively doubling the CGT exemption and potentially reducing the rate of capital gains tax payable for lower rate taxpayers.
- Invest in an ISA / Bed and ISA: Gains made on investments held within an ISA are exempt from CGT. Use your ISA allowance each year to avoid CGT on future gains.
- Contribute to a pension: Making a pension contribution can help you save on CGT by increasing the upper limit of your income tax band.
- Make use of losses: Minimise your CGT liability by using losses to reduce your gain. Report losses to HMRC within four years from the end of the tax year in which the asset was disposed of.
- Give shares to charity: Giving land, property, or qualifying shares to a charity provides income tax relief and CGT relief.
- Invest in an Enterprise Investment Scheme: Gains on investments in an EIS are free from CGT if held for three or more years.
- Claim Gift Hold-Over Relief: This relief may be available if you give away certain business assets or sell them for less than they are worth.
- Chattels that escape CGT: The word ‘chattel’ is a legal term meaning an item of tangible, movable property, something you can both touch and move. Your personal possessions will normally be chattels. Gains on certain Chattels, like antique clocks or vintage cars, are CGT-free if they qualify as "wasting assets".
- Private Residence Relief (PRR): PRR can significantly reduce your Capital Gains Tax liability when selling your main home. This relief applies if the property has been your primary residence for all or part of the time you owned it. However, even if you have not lived in the property continuously, PRR can still apply in certain situations.
Need Help?
At Elite Financial Accounting, we can help ensure you aren’t paying unnecessary CGT and provide expert advice on how best to manage your tax obligations.