It’s hard to like the tax man, more so the one wearing the capital gains tax cap. Capital gains tax can come as a nasty surprise, but as it’s based on investment gains, it should actually be celebrated!
Read on to find out how you can use the capital gains tax rules to your advantage.
Know your enemy
Before we look at ways to combat capital gains tax, we need to know what it is. For tax purposes, capital gain applies to most investment assets including:
- Your primary residence
- An investment property
- Your business
- Shares in a company
- Unit trusts
- Large boats and aeroplanes
The capital gain is the difference between the base cost of the asset (the purchase value plus expenditure incurred to improve the asset) and the sale price of the asset. 40% of this gain is added to your income and taxed at your marginal income tax rate.
Wait, it’s not all bad
Before you get too morose, be aware that there some very important exemptions to the rules. You won’t pay capital gains tax on any of the following:
- The first R2 million on the sale of your primary residence
- 8 million on the sale of a small business (a business with an asset value of less than R10 million)
- Sale of personal assets such as jewellery
A (re)balancing act
Very significantly, there is also a general exemption of R40,000 per year. If you’re invested in a selection of unit trusts such as the Kanan Wealth portfolios, this general exemption allows you to rebalance your investments to re-align the asset allocation to your original goals and risk profile without paying capital gains tax on the first R40,000. Rebalancing involves selling high and buying low. This may sound counterintuitive, but it is a valued investment strategy that helps you to lock in your profits and stay true to your original goals.
Rebalancing your portfolio annually and taking advantage of the R40,000 capital gain exemption not only helps you to maintain an appropriate asset allocation, but it also assists to increase the base cost of your investments. This ultimately means there will be less asset gain – and thus lower capital gains tax – in the future.
Putting theory into practice
At Kanan Wealth we usually advise clients to lower the risk in their overall investment portfolios as they approach retirement (unless they have other guaranteed income, sufficient medical cover and a healthy emergency fund). An example of this would be switching (another term for rebalancing) from our Capital Accelerator and Special Opportunities portfolios into our Stable Growth and Cautious Preservation portfolios : a move that would protect your income while also maintaining sufficient equity exposure to ensure some much-needed capital growth during retirement.
There’s no getting around it
As a successful investor capital gains tax is a sure thing that even applies after your passing, when winding up your estate. You can defer your tax liability by leaving your assets to your spouse, but when he or she passes away, capital gains tax will be paid by the estate – thus lessening the inheritance to your chosen heirs. There is an exemption of R300,000 on death which does assist to reduce the blow, but one of the best ways to avoid a really nasty surprise for your heirs is to rebalance your portfolio annually as outlined above.
Remember that paying any form of income tax is a privilege because it means you’re earning an income and realising gain on investments. But that doesn’t mean you should pay more than your fair share.
Taking advantage of the R40,000 annual exclusion to rebalance your investment portfolio every year will keep your portfolio in line with your original investment goals. What’s more, it will also mean that the base costs of your total investment portfolio increases … Thus sparing you, or your chosen heirs, an unwanted capital gains tax surprise.