Capital Gains Tax Calculation: Case Study
Before considering strategies you can follow to reduce your capital gains tax bill, it’s important to understand exactly how the tax is calculated under the current rules.
CGT can be extremely complex… but it can also be extremely simple.
To show you how it’s calculated, we’re going to look at a property investor called Kate who sells a buy-to-let flat.
We’ll keep tax terminology and jargon to the bare minimum for now because it gets in the way of understanding how capital gains tax is calculated.
Let’s say Kate bought the flat for £200,000 and sold it for £250,000. So she has made a ‘profit’ of £50,000.
However, she probably doesn’t have to pay tax on the whole £50,000 because this is not her true net profit.
She will probably have racked up some costs when she sold the property, such as solicitor fees, estate agent fees and advertising. She will also have paid some costs when she originally bought the property, for example survey fees, stamp duty and more solicitor fees.
These direct costs of buying and selling the property can be deducted when calculating her capital gains tax.
Let’s say her total selling costs are £3,000 and her buying costs were also £3,000. Her net gain is now calculated as follows:
Sales proceeds - £250,000
Less: Purchase price - £200,000
Less: Selling costs - £3,000
Less: Purchase costs - £3,000
Net Gain - £44,000
The net gain calculated after deducting these allowable costs is often known as the chargeable gain.
The final thing we have to do to calculate Kate’s taxable gain is deduct her annual capital gains tax exemption:
Taxable gain = £44,000 - £10,600 = £33,400
What Tax Rate?
Lastly, we calculate Kate’s capital gains tax bill by multiplying her taxable gain by the correct tax rate: either 18% or 28% or a combination of both.
Which rate we use depends on how much income she has:
If Kate has total income (e.g. rental profits, salary, or interest) of more than £42,475 in the current 2012/13 tax year, she will be a higher-rate taxpayer. This means her entire taxable gain will be taxed at 28%:
£33,400 x 28% = £9,352
If Kate’s income is less than £42,475, she will be a basic-rate taxpayer and some or all of her gain will be taxed at 18%.
For example, if she has income of £30,000, this means £12,475 of her basic-rate band will still be available (£42,475 - £30,000).
Consequently, the first £12,475 of her capital gain will be taxed at 18% and the rest at 28%:
£12,475 x 18% = £2,246
£20,925 x 28% = £5,859
Total tax = £8,105
If Kate has no taxable income for the year, or has income of less than her personal allowance (£8,105 for 2012/13), her entire taxable gain will be covered by her basic-rate tax band and be taxed at 18%:
£33,400 x 18% = £6,012
In summary, Kate made a £44,000 net profit selling her flat and will be left with a CGT bill ranging from £6,012 to £9,352, depending on how much income she has earned during the tax year.
Unlike the previous CGT rules – where everyone paid a flat rate of 18% – how much CGT you pay once more depends upon how much income you have earned.