How to protect your passive income from a capital gains tax hike

Chancellor Rachel Reeves has tax rises in her sights at the upcoming Autumn Budget, as she hunts for extra revenue to shore up government finances, and there are rumours capital gains tax (CGT) might be a target.

Reeves is constrained by Labour’s manifesto pledge not to touch the big three taxes – income tax, National Insurance and VAT. But taxes on capital gains aren’t immune, with the Chancellor having already hiked CGT on assets at the last Budget.

Here, Which? explains the rumoured changes, how they could impact your personal finances, and how to protect yourself.

How does CGT work?

CGT is a tax levied on your profits when you sell an asset – such as shares or property – that's increased in value.

It was first introduced by the Labour government in 1965, following a surge in the value of property and other assets after the Second World War.

If you make a gain after selling assets or property, you'll pay 18% CGT as a basic-rate taxpayer, or 24% if you pay a higher rate of tax.

You won't need to pay the tax when selling your main home. There’s also a tax-free annual allowance of £3,000, although this has been cut from £12,300 in 2022-23.

The total CGT taken last year was £12.1bn across 378,000 taxpayers, according to HMRC. The Office for Budget Responsibility (OBR) expects this to more than double to £25.5bn by 2030.

Predicted CGT raised by 2030

• Find out more: Capital gains tax rates and allowances 

What changes to CGT are being discussed?

The Treasury is purportedly considering several options. 

Most discussed is the idea that anyone selling any property, including their main home, for more than £1.5m will be liable for CGT.

If this were charged at 24% for a higher-rate taxpayer, and if someone’s £1.5m home had increased in value by 15% since they bought it, they’d be liable for a £54,000 tax bill, according to Hargreaves Lansdown.

Another option available to the Chancellor is to equalise CGT rates with income tax rates.

CGT is currently charged at 18% for basic rate taxpayers and 24% for higher and additional rate payers. Income tax on the other hand, is charged at 20%, 40% and 45% for basic, higher and additional rate taxpayers, respectively.

Taking our earlier scenario and applying equalised CGT rates would land a higher rate taxpayer with a £90,000 bill, and an additional rate taxpayer with a £101,250 bill.

The government could also make a change so that capital gains no longer reset on death. Currently, gains made on stocks and shares during your lifetime are not considered for CGT purposes after your death, but the Treasury could opt to change this, leading to a higher tax bill for your heirs.

Lastly, there is the option of reducing or abolishing ‘business asset disposal relief’, which applies a discounted CGT rate to business owners when they sell parts of their business.

• Find out more: Capital gains tax on shares

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Why is the government targeting CGT?

Most CGT is paid by a small number of wealthy taxpayers – according to HMRC, last year 40% of CGT came from individuals and trusts who made gains of £5m or more. Any increase would largely be shouldered by the wealthiest in society.

Some experts also argue that it’s unfair to tax unearned wealth (capital gains) at a lower rate than earned income (wages). This disincentivises work and encourages the hoarding of wealth. 

Equalising CGT with income tax would go some way to addressing this, with estimates suggesting it could raise up to £12bn of extra tax revenue per year.

The counter-argument is that any hike to CGT could reduce investment into the UK, as investors may become less inclined to take risks.

• Find out more: Business asset disposal relief

6 ways to protect yourself from a CGT hike

1. Use Isas: any cash or investments held within an Isa are completely free of CGT. You can deposit up to £20,000 into Isas per tax year.
2. Pay into your pension: money paid into a pension will grow free of CGT – plus you get tax relief on contributions added into the bargain.
3. Move existing investments into an Isa: you can move your existing investments into an Isa using what’s known as a ‘bed and Isa’ transaction. This process allows you to sell an asset and repurchase it immediately in an Isa or Sipp.
4. Transfer assets to a spouse: you can transfer ownership of assets to your spouse or civil partner tax free. They can then make use of their own CGT allowance to sell up to £3,000 of assets with no tax due. They can also move transferred assets into an Isa using their own Isa allowance – known as ‘bed and spouse’ Isa.
5. Consider CGT free investments: any capital gains made on UK gilts purchased directly (i.e. outside a bond fund) are not subject to CGT.
6. Don’t forget to include your losses: when you complete your tax return, don’t forget to include losses, as they will be offset against any gains. If you make more losses than gains, claim for the extra, because you can carry them forwards and use them in future.

• Find out more: how to tax-proof your investment portfolio