It’s hard for a long-term property investor in this country to beat inflation by a large margin, whatever he or she buys. Why? Because of Capital Gains Tax (CGT).
Suppose you buy an investment property for £200,000. Over the next 10 years, the value of the property grows by 4.5% each year, after accounting for maintenance costs, fees, etc. Inflation during that time averages 3.5%.
After 10 years, the property is worth over £310,000 — a pretty good return you think (55%), so you sell it. But then comes the Capital Gains Tax bill. You’ll pay 20% or 28% tax on anything over the annual allowance (currently £11,100). If the gain is taxed at a higher rate, the CGT would be just under £28,000, leaving you with just under £282,000, or roughly £71,200 profit.
But this doesn’t show the full picture. Due to inflation, in 2024 £282,000 has exactly the same purchasing power as your original investment did in 2014, so you’ve not really made any money at all!
So what am I saying? As CGT is no longer indexed to inflation (it was until 2008) it’s basically a wealth tax. The more money you put into property investments, the less protection the annual CGT allowance will be against inflation rather than actual capital growth when you come to sell. And the more inflation rises, the greater the pain for UK investors.
As the financial year ends on April 5th, it’s really important to check you have used up any relevant allowances and reliefs to make sure you don’t pay more CGT (or indeed any other tax) than you need to, now or in the future.
This year you can save up to £15,240 in a Stocks & Shares ISA — more than £30,480 for a married couple — but if you miss the April deadline you lose this rare gift from the Chancellor forever. If you continually use your ISA allowance, over time, you could build up a large fund that grows tax efficiently and can be accessed whenever you wish, without paying income or capital gains tax.
Capital Gains Tax Annual Allowance
In addition to the longer-term growth potential, one of the pluses of an investment portfolio that includes stocks and shares (either directly, or through investment funds) is that you can sell some holdings each year to use your annual CGT allowance, rather than leaving any gains to build and – as in the example above – be taxed heavily when you sold. For example, a gain of £54,500 could be cleared completely over five years even if the annual allowance remains at £11,100. This could stave off a tax bill of £15,000 for a higher rate taxpayer.
Pensions can also be highly tax-efficient. It is often a good idea for business owners, to make pension contributions as part of an overall financial planning strategy. Any payments will reduce top-line profit (and move these pre-tax earnings into your own name), and also make you less dependent on the eventual sale of the business to fund your retirement income.
There is no capital gains or income tax* to pay on pension asset growth, which could represent a not-insignificant saving for the long-term investor. Unfortunately, while the ISA allowance generally increases each year, the annual pensions allowance has fallen hugely since 2011. Should you be increasing your pension investments now?
*Withholding tax on UK dividend income cannot be reclaimed.
Ian Thomas is authorised and regulated by the FCA. This article is intended to provide helpful information of a general nature and does not constitute financial advice.