Investing Wisely — Understanding Long Term Capital Gains Tax

Read on and take some advice on mastering the world of long-term capital gains tax.

Updated: May 20, 2024
Matt Crabtree

Written By

Matt Crabtree

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Are you wanting to invest in the stock market but are intimidated by the prospect of dealing with long term capital gains taxes? Don't worry — we've got you covered!

Investing is an integral way to build wealth, but it does come with its challenges. One such challenge is understanding long term capital gains tax and how to reduce the amount of taxes you have to pay.

In this article, we'll discuss the basics of long term capital gains tax and provide some strategies on how to invest wisely to reduce your tax burden.

So, if you're ready to start investing with confidence, read on and take some advice on mastering the world of long-term capital gains tax!

The Basics of Long Term Capital Gains Tax

What Are Capital Gains Taxes & How Do You Calculate Them?

Capital gains taxes make up part of the total tax liability for investors.

This type of tax is assessed on the amount of money earned from investments such as the sale of stocks, bonds, real estate, and other assets. Calculating capital gains tax can be complicated, but understanding how these taxes work and the available deductions can help investors reduce their overall tax burden.

Capital gains taxes are typically assessed when an investor sells an asset for more than what they purchased it for. For instance, if you buy a stock for £100 and sell it for £200, you've earned a £100 capital gain. The total capital gains tax you will pay depends on your personal tax bracket and the length of time you held the asset.

Short-term VS. Long-term Capital Gains Tax

Short Term Capital Gains Tax. This is applied when an investment has been held for no more than one year. This type of tax is set at the same rate as income tax and is determined by the individual’s highest income tax bracket. This means that investors in the higher tax brackets may be subject to higher rates of short term capital gains tax.

Long Term Capital Gains Tax. Conversely, this applies when an investment has been held for more than a year. It's set at a lower rate compared to short term capital gains tax and is usually set at either 10 or 20 percent. This lower rate encourages long-term investment and is generally beneficial to investors in the long run.

Investing in assets with a long-term horizon, such as index funds, can often yield lower gains, and thus lower taxes, than short-term investments, such as day trading.

Capital Gains Tax Calculator

The first step to calculating capital gains taxes is determining your total capital gains for the year. This includes any profits from the sale of investments like stocks, bonds, and real estate.

The amount of taxes you owe is then calculated by multiplying your net capital gains by your marginal tax rates. This is based on your ordinary income tax rate and filing status. You may also be able to take advantage of any capital gains tax exclusions or deductions available, which can reduce your overall tax liability.

Knowing how capital gains taxes work and how to calculate them can help investors ensure they’re making the most of their investments and minimising their tax liability. With a better understanding of these taxes, investors can make more informed decisions and pursue investment strategies that minimise their taxes and maximise their returns.

When Is Capital Gains Tax Due?

Capital gains tax is due when you receive the proceeds of the sale.

In the UK, capital gains tax is usually due 30 days after the sale of the asset. Depending on the value of the sale, you may need to declare capital gains tax on the next self-assessment tax return you complete.

It is important to remember that capital gains tax is payable on the day after the sale, so it is crucial to plan ahead and ensure that you have the money available to make the payment.

Are There Any Penalties For Not Paying Capital Gains Tax?

Late Filing Penalties

HM Revenue & Customs (HMRC) has a strict policy for filing CGT returns. If you miss the deadline to properly file your CGT return, you may be charged a penalty which is usually a percentage of the total tax due. The rate of penalty will vary depending on the length of the delay and the amount of tax due.

If you fail to file your CGT return within two months of the filing deadline, you may be required to pay an initial penalty of £100. If you then remain non-compliant after a further three months, you could face an additional daily penalty of £10 per day, up to a maximum of £900.

Late Payment Penalties

If you miss the payment deadline for any tax that is due as a result of a CGT liability, you may be liable for an additional penalty. The rate of penalty for late payment is normally 5% of the amount due, plus an additional 5% for each additional payment period of 90 days following the payment deadline.

Reducing Or Waiving Penalties

In most cases, HMRC will have discretion to reduce or waive any penalties charged if you can prove that you have taken reasonable steps to ensure your compliance. You may also be able to reduce or waive the penalty if your delay in filing or paying the tax due is due to exceptional circumstances.

It is important to note that merely forgetting to file or pay, or being unable to afford the payment, are not considered reasonable excuses by HMRC. 

As such, you should take steps to ensure that you are compliant with the filing, and payment, deadlines.

Strategies for Minimising Capital Gains Tax Liability

If you’re an investor, you know that the tax man will eventually come knocking to capture some of your investment profits. One way to reduce your tax liability on those investments is to use a variety of strategies to minimise your long-term capital gains tax) bill.

1. Invest In Tax-Advantaged Investments.

There are several types of tax-advantaged investments available in the UK, including ISAs, SIPPs, and Venture Capital Trusts (VCTs). Each of these investments offers tax advantages, such as no capital gains tax or income tax on profits. 

2. Take Advantage Of Reliefs & Allowances.

The UK government provides a range of reliefs and allowances to investors, such as Entrepreneurs’ Relief, Capital Gains Tax Allowance, and the Annual Exempt Amount. These reliefs and allowances can reduce the amount of tax you owe on your long-term investments.

3. Utilise Tax-Loss Harvesting.

Tax-loss harvesting is a strategy whereby investors realise losses on their investments and then use those losses to offset the tax they owe on the gains from other investments. This strategy can be particularly useful for investors who are planning for retirement, as it can help to minimise their tax liability.

4. Utilise Tax-Deferred Accounts.

Tax-deferred accounts, such as Individual Savings Accounts (ISAs) and Self-Invested Personal Pensions (SIPPs), offer investors the opportunity to defer paying tax on the income or capital gains earned within the accounts. This allows investors to maximise their returns while reducing their overall tax liability.

5. Consider charitable donations.

Giving to charity not only has the potential to make a positive difference in the world, but it can also help to reduce your overall tax liability. Donations to qualifying charities are eligible for tax relief of up to 25% in some cases, which can significantly reduce the amount of tax you owe on your long-term investments.

Who Does Long-Term Capital Gains Tax Impact?

As mentioned, long-term capital gains tax is a levy imposed on the profit made from investments that have been held for over a year. Investors and traders, who have made a profit from such investments, will be liable to pay a certain rate of tax on their profits.

It is vital that anyone profiting from investments bear in mind the long-term capital gains tax implications.

Income Taxpayers

One of the main reasons why long-term capital gains tax can have an impact on income taxpayers is that it is applied at a different rate than income tax. In the UK, the rate of long-term capital gains tax is generally lower than the rate of income tax.

However, if an individual's total income (including capital gains) exceeds the higher rate threshold for income tax, the long-term capital gains tax rate increases.

Generally, it's crucial to be aware of long-term capital gains tax and to consider the potential tax implications of selling any assets that may be subject to this tax. By understanding how long-term capital gains tax works, individuals can make informed decisions about when to sell assets and can potentially minimise the impact of this tax on their overall income.

Investors and Traders

Investors and traders of stocks, bonds, commodities and other financial instruments are most likely to be affected by long-term capital gains tax. Such investors and traders should be mindful of the tax implications when making profit from investments. They should also keep detailed records of their investments to ensure that they are not liable for more tax than what is due.

Long term capital gains (LTCG) can also have implications for traders, as it can affect their ability to make short-term profits. If an investor buys a stock and sells it in a short period of time, they are subject to a short-term capital gains tax rate, which is generally higher than the long-term rate.

Therefore, if an investor wants to make a quick profit, they may want to consider holding their investments for at least a year before selling them in order to benefit from the lower long-term rate.

Finally, the LTCG rate can also impact how investors and traders structure their portfolios. For example, a trader who is looking for a higher return on investment needs to understand the tax implications of their investments in order to maximise their profits. 

If an investor knows that they are in a higher tax bracket and subject to a higher tax rate, they may want to focus more on long-term investments in order to benefit from the lower LTCG rate.

Inheritors

Those who inherit significant assets such as stocks and bonds are also impacted by long-term capital gains tax. Any profits from the sale of inherited assets will be subject, and the holding period of the asset prior to the sale will also be taken into account when calculating the rate of capital gains tax due.

Entrepreneurs

Entrepreneurs may also be impacted by long-term capital gains tax when selling the ownership of their business. Profits made on the sale of a business will be prone to capital gains tax, and the rate of tax levied will depend on the time since the original purchase as well as other factor

Avoiding Common Capital Gains Tax Mistakes

Many investors make costly mistakes when it comes to their capital gains tax, leading to overpayments of taxes and lost investment opportunities. To avoid these mistakes, it’s important to have an understanding of the capital gains tax and its related issues. Let's take a look at some tips to help any unnecessary tax burdens.

Take Advantage Of Capital Gains Tax Exemptions. The CGT does not apply to all types of capital gains. Certain assets, such as certain stocks, bonds, and certain types of investment properties, are eligible for a capital gains tax exemption. 

Know The Holding Period Requirement. The holding period requirement determines when an asset is eligible for capital gains tax. Different assets have different holding periods, so it’s important to understand the holding period requirements for the type of assets that you are investing in.

Generally, assets held for at least one year are eligible for long-term capital gains tax, while assets held for less than one year will result in short-term capital gains tax.

Consider The Timing Of Disposition. The timing of when an asset is sold will also affect its capital gains tax status. Investors should always consider the current tax environment and the likely tax consequences of an asset sale before deciding when to sell an asset.

Review The Cost Basis Of Your Investments. When an asset is sold, your cost basis will be used to calculate the taxable gain or loss. Investors should always make sure that their cost basis is accurate and up to date. Failing to do so could lead to overpayment of capital gains tax due to incorrect calculation of the taxable gain or loss.

Use Capital Loss Carryovers. Capital losses can be used to mitigate capital gains in the current tax year. Any capital losses in excess of the capital gains can be carried forward to future tax years. Doing so can reduce the amount of capital gains tax that investors have to pay in future years.

By taking the time to familiarise yourself with the capital gains tax and the tips outlined above, you can avoid common capital gains tax mistakes and reduce your tax liability. 

Always remember to consult with a tax professional before making any major investment decisions to ensure that you understand the tax implications of your actions.

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