2021 Potential Capital Gains Tax Changes and Impact on Inheritance Tax

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Simon Misiewicz

17th December 2020

2021 Capital Gains Tax changes?

You may be interested in our main article on Capital Gains Tax rates and allowances. You may also be interested to know how more about our services to help reduce your Capital Gains tax liability when you sell a buy to let property investment.

Back in November 2020, the Office of Tax Simplification (OTS) reported a list of changes to Capital Gains Tax (CGT) in the UK. These changes are so significant that they recommend the biggest shake-up to the taxation of assets for many years.

The changes to Capital Gains Tax could affect the lives of many UK landlords. Most of all, the changes to CGT will affect how much Inheritance Tax (IHT) investors will pay before assets are passed onto loved ones.

This article goes deeper into these Capital Gains Tax changes and how they impact Inheritance Tax.

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Part 1: Capital Gains Tax Explained

Capital Gains Tax is the taxation of the profit made from selling a property investment.

The Chancellor of the Exchequer Rishi Sunak invited the OTS in July 2020 to write a list of recommendations of how Capital Gains Tax may be made more adnistrative efficient and in line with other forms of tax. The OTS report is yet to be reviewed by Rishi Sunak, who may then implement some of the recommendations made by the OTS

The study focuses on a broad range of topics surrounding CGT. Although this article covers the relationship between CGT and IHT, it’s worth delving further into how it can affect your future property tax liabilities.

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Current Capital Gains Tax and inheritance tax

The current rates for CGT are as follows:

– Tax-Free Allowance: £12,300 for one person and £24,600 for a couple.

– Basic Rate Tax: 10% for non-residential properties, and 18% for residential properties.

– High Rate Tax: 20% for non-residential properties, and 28% for residential properties.

And the rates for IHT are as follows:

– Tax-Free Allowance: £325,000 for one person and £650,000 for a couple.

– Home Band: Extra £175,000 or £350,000 for homes valued over £325,000.

– Taxable Rate: 40% for primary and high-rate taxpayers.

IHT Rates for Gifting Assets

Gifting assets is often interpreted by the taxman as a tax loophole. You can give your assets to a loved one without any tax. Once the IHT lifetime allowance is used a tiered tax structure works how much IHT you will pay on your estate.

You may suffer inheritance tax on gifts that you have made during your lifetime. This is called a 7-year clawback. The figures provided below are the total IHT figure, not the level of reduction.

– Under 3 years – 40%

– 3-4 years – 32%

– 4-5 years – 24%

– 5-6 years – 16%

– 6-7 years – 8%

– More than 7 years – 0%

It’s easy to see why gifting assets is so popular, especially among those close to retirement.

Reduced tax costs are also the reason why Her Majesty’s Revenue and Customs (HMRC) do not seem to like this tax loophole.  The OTS look to close this tax loophole up and make sure that tax is due where HMRC believes it is due.

Rates for Income Tax

These might not change based on OTS report but may influence other areas of interconnecting taxes. The current rates of Income Tax are as follows:

– £0 to £12,500 – 0%

– £12,501 to £50,000 – 20%

– £50,001 to £150,000 – 40%

– Over £150,000 – 45%

 

Part 2: Proposed Capital Gains Tax Changes for 2021

Under the proposed system discussed in the OTS report, CGT may blend into a tax structure similar to that of Income Tax.

This system pushes the rates up from 10%/18% to 20%, and 20%/28% to 40%. When combined with the Capital Gains topping up one’s income, it will push many basic taxpayers into top tax bracket of 45% tax.

How Income Tax Affects Capital Gains Tax

In the proposals above, for example, if you sell a vase for £10,000, you bought for £50 at an auction you don’t pay any tax.  This is because the amount of profit is under the £12,300 Capital Gains Tax exempt annual allowance. If the same vase was worth £20,000, the tax applied would be 10% over and above the £12,300 Capital Gains Tax exempt amount.

It’s worth looking at tax calculators for making sure you know your tax liabilities and identifies innovative ways to reduce them

Under the new proposals by the OTS, the £9,950 profit could be taxed at income tax rates. If you work part-time and earn £15,000 per year, you will find yourself paying 20% income tax on that £9,950, which is £1,990 in tax.

How CGT as Income Tax Affects Gifting Assets

Currently, if you inherit a property that probate valued at £100,000, and you sold this for £100,000 the profit is £0. Thus there is no CGT due.

In the OTS proposals, the cost of an asset in the hands of the recipient will be the purchase cost of the person giving the asset.

For example, it assumes that the beneficiary paid £50,000 for the asset, and you sold it for £100,000. The new valuation means you now have £50,000 of taxable gains.

Under the same OTS recommendations, the £50,000 would not be taxed under Capital Gains Tax after the £12,300 annual exemption but tax under income tax rules.

Part 3: What Does This Mean for Inheritance Tax?

From a probate perspective, the reduced valuation of the base rate may appear to be good news. In particular, this is true if you choose not to sell the inherited assets in the short term, as it may drop your assets below the £325,000 threshold for your own inheritance tax planning

But, if you die, then your beneficiaries will receive the hefty Inheritance tax bill based on the market value, not the base cost.

If you choose to sell the asset from your estate, you may receive a surprisingly large tax liability. Some consolation exists in knowing that if you sold an investment before the year 2000, the recommendation is that the value in the year 2000 stands. In most cases, this will see the level of CGT decrease.

It also affects gifting assets as well as inheriting them. Even if the 7-year clawback remains at the current rates, the amount of tax paid will be higher if they are aligned with income tax rates.

What are the Options if the proposed CGT changes come into affect?

If all this leaves you wondering what the options are to make sure your hard-earned wealth doesn’t disappear into the taxman’s hands, do not worry as there are three options.

Whichever you choose, getting advice from a professional is always recommended.

– Gift Sooner Rather Than Later: You’ll remain under the current taxation laws, and have the pleasure of passing assets over to loved ones. For many, it isn’t about luxury cars and holidays; it’s about having four walls and a roof to call their own.

There are ways to minimise Capital Gains tax when gifting assets.

– Sell Up: Take your profits, cut your losses. You can then decide where the money is invested or spent. If you don’t have a family, you could always change someone else’s life by donating to charity. Alternatively, you could take that round-the-world trip you always wanted. There are ways that UK landlords can reduce CGT when selling buy to let properties.

– Leave the Country: The most drastic situation on the list. However, there are many countries which offer more generous allowances on inheritance tax. It is also an opportunity to experience the world.

Whatever the Outcome, Make Sure You Are Ready

As you can see, the new rules surrounding Capital Gains Tax will have a negative impact on hard-working families, who have seen their assets grow over time.

You should now look at your finances and potential tax liabilities. Try and work out how the proposed OTS changes to CGT could affect your back pocket.

This is especially the case in 2020 where thousands of young people are losing their jobs. You may wish to provide gifts to help create financial stability for loved ones.

The OTS recommendations are just that, recommendations. They are yet to pass through parliament. That said, if they do, they will change the landscape of inheritance tax planning forever.

Please book a tax consultation to see how you can make sure you prepare for any future tax changes.

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