Using capital losses and the annual CGT exemption

by Malcolm Finney of www.taxinsider.co.uk

Care is required to ensure that an individual’s annual exempt amount for capital gains tax (CGT) purposes is not wasted; in particular, where capital losses are also available for offset.

Annual exempt amount

The annual exempt amount refers to the amount of capital gains (after offset of capital losses) that is exempt from CGT for a tax year. For the tax years 2011-12 and 2012-13 the annual exempt amount is £10,600.

Rates of capital gains tax

For the tax years 2011-12 and 2012-13 CGT is levied at 18 per cent and/or 28 per cent, depending upon the marginal rate of income tax of the individual.

Capital losses

Where an individual makes a capital loss in order for it to be utilised (i.e. offset against any capital gains) it must be claimed by the individual (in the tax return). The manner in which an individual’s capital losses are to be offset against capital gains is set out in legislation.

Thus, any capital losses that arise in a tax year must be offset against any capital gains for that tax year; this is compulsory. Unfortunately, this may mean that an individual’s annual exempt amount for that tax year is wasted.

Example 1

In the tax year 2011-12 Terry sold a number of his assets and made capital gains of £15,000 and capital losses of £6,000. The annual exempt amount is £10,600. Net capital gains = [£15,000 - £6,000] = £9,000. Capital gains subject to CGT = £9,000 - £10,600 = Nil.

As up to £10,600 of net capital gains is exempt from CGT, the surplus £1,600 (i.e. £10,600 less £9,000) is lost, i.e. cannot be used (by carrying it backwards or forwards).

Capital losses of previous tax years which are unutilised may be carried forward indefinitely for offset against subsequent tax year capital gains; where this occurs, current tax year capital losses are offset before any capital losses brought forward from earlier tax years may be used.

However, some control of the usage of capital losses brought forward is possible. Any such losses may be offset against the net gains of the tax year but only to the extent necessary so as not to waste any of the annual exempt amounts for that tax year. 

Any remaining unused capital losses may then be carried forward to the next and succeeding tax years until fully utilised.

Example 2

In the tax year 2011-12 Terry sold a number of his assets and made capital gains of £25,000 and capital losses of £5,000. He has unused capital losses brought forward from earlier tax years of £13,000. The annual exempt amount is £10,600. 

Net capital gains = [£25,000 - £5,000] – [£13,000] = £7,000. Capital gains subject to CGT = £7,000 - £10,600 = Nil.

However, Terry is allowed to utilise only so much of the capital losses brought forward, which prevents any loss of the annual exempt amount. 

Thus: Net capital gains = [£25,000 - £5,000] – [£9,400] = £10,600. Capital gains subject to CGT = £10,600 - £10,600 = Nil. 

In this case Terry pays no CGT and has only used £9,400 of his capital losses brought forward, thus leaving £3,600 of capital losses brought forward to be carried forward to tax year 2012-13 and later tax years.

It may also be sensible to defer sales of assets precipitating capital gains into the following tax year if the individual’s rate of income tax is likely to be lower next tax year and/or bring forward to the current tax year sales of assets likely to precipitate capital losses in order to contain any CGT charge to the 18 per cent, instead of the 28 per cent, rate whilst also not wasting the annual exempt amount.

Example 3

In the tax year 2012-13 Harry is a 40 per cent taxpayer. In the tax year 2013-14 Harry expects to be a 20 per cent taxpayer. He has sold assets in 2012-13 making capital gains of £20,600, which after the annual exempt amount of £10,600 produces capital gains subject to CGT of £10,000. CGT is thus 28 per cent of £10,000, i.e. £2,800.

If Harry had made the sales in 2013-14 instead, his CGT would have been 18 per cent of £10,000, i.e. £1,800.

Example 4

In the tax year 2012-13 Harry is a 20 per cent taxpayer as his taxable income is £30,000 (above £34,370 income tax is levied at 40 per cent). He wants to sell assets in 2012-13 which would make capital gains of £20,600, which after the annual exempt amount of £10,600 produces capital gains subject to CGT of £10,000. CGT would then equal [[£4,370 x 18%] + [£5,630 x 28%]] = £2,363.

He also owns an asset on which, if he sold it, he would make a capital loss of £5,630. It would make sense to sell it in 2012-13 as then his net capital gains would be: [£20,600 - £5,630] = £14,970. 

After deducting the £10,600 produces £4,370 of capital gains subject to CGT. CGT would then be [18% x £4,370] = £787.

Harry has avoided paying CGT at the rate of 28 per cent.

Practical tip:

Before the end of a tax year check whether the 28 per cent rate of CGT can be avoided by possibly deferring sales on which gains would arise and/or by bringing forward sales on which capital losses would arise.

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Published on: August 1, 2012

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