How investors are protecting themselves from increased capital gains tax

Capital gains tax shot up this Autumn, and investors are already changing their behaviour in response.

Whenever investors sell assets or investments at a profit, the profits they make are subject to capital gains tax (CGT). Capital gains tax works by charging tax on the profits made when assets are disposed of (i.e., sold).

A wide range of assets are subject to CGT, including second homes, most personal possessions worth over £6,000 (apart from cars), and business assets, as well as any shares not held in a tax-efficient investment product such as investment savings accounts (ISAs) or self-invested personal pensions (SIPPs). As such, CGT can be a significant drag on investors’ returns, especially given the size of some of the assets involved.

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As Laith Khalaf, head of investment analysis at AJ Bell, puts it: “for most people capital gains build up on assets purchased with money that has already gone through the income tax wringer, so capital gains tax represents a second wave of taxation.”

What’s more, an increased capital gains tax rate threatens to compound this burden. Following changes by Rachel Reeves in her Autumn Budget, the capital gains tax rate increased from 10% to 18% for lower rate taxpayers and from 20% to 24% for those on the higher rate. These increases apply to any assets sold from 30 October 2024.

A basic rate taxpayer who sells a second home for £100,000 profit will pay £8,000 more in tax now than three months ago, thanks to the capital gains tax increase.

Capital gains tax receipts were already increasing from before the Budget was announced.

“Receipts were around £180 million more in the period from April to October 2024 compared the same period a year earlier,” said Rachael Griffin, tax and financial planning expert at Quilter. “Some investors and property owners will have moved to offload assets ahead of the widely anticipated CGT increases announced in the recent budget.”

How can investors protect themselves from the capital gains tax increase?

There are some steps that you can take in order to reduce your capital gains tax bill.

One simple one is to ensure that as many of your assets as possible are held in a tax-efficient wrapper, such as an ISA or SIPP.

Research from Charles Stanley Direct shows that over a quarter of investors have done exactly this since the October capital gains tax hike.

Charles Stanley surveyed 1,000 UK-based DIY investors, and 27% responded to say that they had moved more of their investments into a tax-efficient product like an ISA or SIPP in order to reduce their capital gains tax bill.

“DIY investors have been tasked with reevaluating their investments to make the most of their money following the announced increase in Capital Gains Tax,” says Rob Morgan, chief investment analyst at Charles Stanley Direct.

Why do ISAs help reduce capital gains tax?

While selling most assets will incur CGT, there are some exceptions. For a start, everyone has an individual threshold of £3,000 annually – so you can make £3,000 of gains on your assets every year without incurring any CGT at all. You also don’t usually pay CGT when selling the house that you live in.

Stocks and shares are liable to CGT, but only if they’re held outside an ISA (or other investment products such as SIPPs). This is why DIY investors have used these wrappers to protect themselves from CGT.

There is, of course, a limit of £20,000 per year to the amount that you can invest through ISAs. However, once your money is in an ISA, your investments are free to gain as much value as they can, and you won’t be taxed on their sale. (They’ll also benefit from other tax breaks, such as avoiding dividend tax on shares held in a stocks and shares ISA).

It’s worth remembering that everyone has a £3,000 personal allowance, meaning that they won’t be taxed on the first £3,000 gains they make from investments in any given year, regardless of where the assets are held.

“While the hike was less drastic than widely anticipated, it is still important to take stock and ensure your portfolio is correctly positioned,” says Morgan, “whether [by] investing in tax-free assets or better utilising the whole family’s tax-free allowances.”

Nearly a fifth (17%) of respondents to Charles Stanley’s survey said that they wouldn’t make any change to their investing habits, as they don’t currently pay CGT. In other words, they haven’t made £3,000 of profits on taxable assets, such as buy-to-let homes or stocks and shares outside an ISA.

How else can you reduce your CGT bill?

Charles Stanley’s research found that investors are using a variety of means to cut their CGT bill, including making fewer trades (which 23% of respondents said they would do) and rebalancing their investment portfolios towards assets that don’t incur CGT (21%).

You could also consider deferring the sale of an asset into the next tax year, in order to keep below your CGT allowance in the current year. Assets sold at a profit in years when others are sold at a loss can be offset against each other, which will reduce your total CGT bill.

All this said, it is worth considering the tradeoff between being taxed on your asset sales, and limiting their potential growth by trying to reduce CGT.

“Tax considerations are only part of the equation,” says Morgan. “Hoarding cash in fear of being taxed on investments can drag back the wealth building process, leading to stagnation of income rather than growth.”

To underscore this point, 10% of respondents told Charles Stanley that they wouldn’t be making any changes to their strategy, despite the CGT increase, because they are comfortable with the amount they are currently paying.