Educating yourself about this tax will help you avoid its common pitfalls and will help you better formulate a tax efficient succession plan. It’s essentially a tax on capital gains. In other words, it’s a tax payable on the profit which results when you dispose of a capital asset (an asset like stocks, bonds or properties).
Many countries around the world have Capital Gains Tax, including the USA, the UK, Canada, Australia, and South Africa, amongst others. These governments have imposed Capital Gains Tax to widen the tax net and lower the rate of personal income tax. The rate of Capital Gains Tax differs from country to country.
How Capital Gains Tax works
When you dispose of a capital asset for a higher price than that for which you purchased it, you have made a capital gain. Capital gains are not always made on the disposal of an asset though – sometimes, the selling price of an asset is less than its purchase price. This is known as a capital loss.
Calculating a capital gain is straightforward – simply subtract the higher selling price from the lower purchase price. For example, if you buy a property for US$200,000 and sell it on some years later for US$4 00,000, then you have realized a capital gain of US$200,000. Capital Gains Tax then becomes payable on this amount.
Remember, such tax only becomes due when you realize the gain, in other words, upon an asset’s disposal.
How can capital assets be disposed of?
- Through their sale
- Through your death
- Through their destruction.
Depending on where you live, Capital Gains Tax may be payable in the event of each of these three means of disposal. For example, in Canada, Capital Gains Tax is payable by the estate upon death, whereas in the UK and South Africa it isn’t (although other taxes may be incurred).
When contemplating how to dispose of your assets, do check with your financial and legal advisors to ascertain the precise nature of the laws and regulations of the jurisdiction in which you live.
How to get relief from Capital Gains Tax
When considering succession planning, as it relates to your assets, consider the following options for tax relief:
- Take out a good life insurance policy to cover the payment of any duties due upon your death
- Transfer part or full ownership of assets to your successor whilst you’re still alive
- Transfer assets to a family trust, and name your successors as beneficiaries
- Transfer assets to a charitable trust (give the equity to a charity).
Although these moves may trigger immediate capital gains payable by you, your successors won’t have to pay such taxes until they decide to dispose of the assets or upon their own death.
Are there any exemptions from Capital Gains Tax?
Depending on the country in which you live, certain assets may be exempt from Capital Gains Tax; for example, in the USA, qualified farms and small business shares. In most countries, including the USA, UK and South Africa, one’s principal residence is exempt from Capital Gains Tax.
If you own several properties – like a house in the city and a cottage by the sea – it is therefore advisable to name the residence of the highest value as your primary residence. Do chat to your financial planner to see whether you qualify for any exemptions.
What has your experience with Capital Gains Tax been in your own country?