Capital gains tax - Calculation of gains and allowable deduc...

Learning Outcomes

This article outlines the fundamental principles for calculating capital gains tax (CGT) in England and Wales. It details how to determine chargeable gains arising from the disposal of assets and identifies the main types of expenditure that can be deducted. Key reliefs available to reduce CGT liability are also introduced. After reading this article, you should understand the core steps in calculating a capital gain or loss, recognise common allowable deductions, and identify the basic operation of major reliefs relevant to the SQE1 assessment. The content also explains when market value must be substituted, how connected person transactions are treated, how special rules apply to chattels and a main residence, and the order in which losses and the Annual Exemption are applied to gains.

SQE1 Syllabus

For SQE1, you are required to understand the practical calculation of CGT for individuals and unincorporated businesses. This involves applying the rules for calculating gains, identifying allowable deductions, and recognising the availability and effect of main reliefs and exemptions, with a focus on the following syllabus points:

• the method for calculating gains and losses on asset disposals
• identifying and applying allowable deductions such as acquisition and disposal costs, and improvement expenditure
• understanding the application and effect of key reliefs, particularly Business Asset Disposal Relief (BADR) and the Annual Exemption
• distinguishing between different types of assets and disposals relevant to CGT
• the market value rule on gifts and non-arm’s length disposals, especially to connected persons
• chattels (tangible moveable property): the £6,000 threshold and the 5/3ths cap for gains and losses
• private residence relief (main home) and its core conditions
• no gain/no loss transfers between spouses or civil partners and their planning effect
• basic CGT rates and residential property surcharge, and how capital gains interact with income in the rate calculation.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the basic formula for calculating a capital gain?
2. Which of the following costs might be an allowable deduction when calculating a capital gain? a) The original purchase price of the asset.
   b) Fees paid to a solicitor for handling the purchase.
   c) Costs of routine maintenance during ownership.
   d) Costs of building an extension that increased the asset's value.
3. True or false? The Annual Exemption can be carried forward if unused in a tax year.
4. What is the main benefit of Business Asset Disposal Relief (BADR)?

Introduction

Capital Gains Tax (CGT) is levied on the profit (gain) realised upon the disposal of certain assets. For SQE1 candidates, a firm understanding of how to calculate these gains and what deductions are permissible is essential. This involves understanding the components of the calculation: disposal proceeds, acquisition costs, and allowable expenditures. Additionally, awareness of key reliefs can significantly alter the final tax liability. This article focuses on these core calculation principles and allowable deductions as they apply to individuals and unincorporated businesses within the scope of the SQE1 syllabus. CGT is governed principally by the Taxation of Chargeable Gains Act 1992 (TCGA 1992). Calculations must also take into account rules on market value substitution, connected persons, the treatment of chattels, and the interaction between gains and income bands when determining the applicable CGT rate.

Key Term: Chargeable Asset
Most forms of property owned by an individual or business, including land, buildings, shares (outside ISAs/PEPs), and valuable personal possessions (chattels worth over £6,000). Specific exemptions apply, notably an individual's main private residence (subject to conditions).

The Basic CGT Calculation

The fundamental calculation for determining a capital gain or loss involves subtracting the allowable costs associated with an asset from the proceeds received upon its disposal.

Identifying a Chargeable Disposal

A disposal event triggers CGT. This typically involves selling an asset, but also includes gifting, swapping, or receiving compensation (like an insurance payout) for an asset. The asset disposed of must also be a chargeable asset.

Where a transaction is not at arm’s length (for example a gift) or is between connected persons, the law generally substitutes market value for actual consideration received to prevent manipulation of gains or losses. Special apportionment rules apply where only part of an asset is disposed of (a “part disposal”).

Key Term: Connected Person
Broadly includes a spouse or civil partner, relatives (such as parents, children, siblings), certain trustees, and companies controlled by the individual or persons connected with them. Transactions between connected persons are treated as taking place at market value.

Key Term: Disposal Proceeds
The amount received (or deemed market value) for the disposal of a chargeable asset, less any incidental costs directly related to the disposal (e.g., estate agent or legal fees on sale).

Key Term: Acquisition Cost
The original cost of acquiring the asset, plus any incidental costs directly related to the acquisition (e.g., stamp duty, legal fees on purchase).

Calculating the Gain

The basic steps are:

• Determine Disposal Proceeds: This is usually the sale price received. For gifts or non-arm’s-length sales (including disposals to connected persons), market value is substituted.
• Deduct Acquisition Cost: The original price paid for the asset, including incidental costs of acquisition.
• Deduct Allowable Expenditure: Capital costs incurred during ownership that increase the asset’s value and are reflected in its state at disposal, plus incidental costs of disposal.

Where only part of an asset is disposed of, the acquisition cost must be apportioned between the part disposed of and the remainder by reference to market values at the time of disposal. A common apportionment formula is: Allowable cost attributed to the part disposed = Total cost × Disposal proceeds ÷ (Disposal proceeds + Market value of the part retained).

The result of this calculation (Disposal Proceeds − Acquisition Cost − Allowable Expenditure) is the basic gain or loss before considering reliefs, losses, the Annual Exemption and tax rates.

Special identification rules for shares

For quoted or widely held shares, disposals are matched in the following order:

• shares acquired on the same day,
• shares acquired within the following 30 days (“bed and breakfast” rule),
• shares from the general s.104 pool (average cost of holdings). This prevents short-term purchases from artificially sheltering gains.

Allowable Deductions

Certain expenditures incurred on the asset during the period of ownership, or in the process of acquiring or disposing of it, can be deducted from the gain. These are set out in TCGA 1992, s 38.

Key Term: Allowable Expenditure
Costs that can be deducted when calculating a capital gain. These primarily include the acquisition cost, incidental costs of acquisition and disposal, and capital enhancement expenditure reflected in the asset’s state at disposal.

Incidental Costs of Acquisition and Disposal

These are costs directly associated with buying or selling the asset.

• Acquisition Costs: Examples include surveyors' fees, legal fees, and Stamp Duty Land Tax (SDLT) paid on the purchase of property.
• Disposal Costs: Examples include estate agents' commission, auctioneer and advertising costs, and legal fees incurred on the sale.

Improvement Expenditure

This refers to capital expenditure incurred during ownership that increases the value of the asset, provided the improvement is reflected in the asset's state or nature at the time of disposal.

• Examples: Cost of building an extension to a property, structural alterations, or significant upgrades to plant that alter its character.
• Exclusions: Routine maintenance and repairs, insurance, mortgage interest, and any expenditure deductible against income tax are generally not allowable enhancement expenditure for CGT.

Key Term: Part Disposal
A disposal of a part or an interest in an asset. The original cost is apportioned between the part disposed of and the remainder, usually by market value ratios at the time of part disposal.

Worked Example 1.1

Anya bought an investment property in 2015 for £200,000, incurring £3,000 in legal fees and £6,000 in SDLT. In 2018, she spent £40,000 building an extension. In 2023, she sold the property for £350,000, paying £5,000 in estate agent fees and £2,000 in legal fees. Calculate Anya's basic gain.

Answer:
Disposal Proceeds: £350,000 − £5,000 (estate agent) − £2,000 (legal fees) = £343,000
Acquisition Cost: £200,000 + £3,000 (legal fees) + £6,000 (SDLT) = £209,000
Improvement Expenditure: £40,000
Basic Gain = £343,000 − £209,000 − £40,000 = £94,000

Worked Example 1.2

Part disposal. In 2024, Karim sells 30% of a plot of land for £90,000. The remaining 70% has a market value of £210,000 at the disposal date. Karim originally acquired the whole plot in 2016 for £200,000 plus £5,000 legal fees. Calculate the allowable cost attributable to the part disposed of and the gain before reliefs.

Answer:
Total historic cost: £205,000
Apportioned cost to part disposed = £205,000 × £90,000 ÷ (£90,000 + £210,000) = £205,000 × 90,000 ÷ 300,000 = £61,500
(Assume no incidental disposal costs.)
Gain before reliefs = £90,000 − £61,500 = £28,500

Application of Reliefs and Exemptions

Annual Exemption (AE)

Individuals have an annual exempt amount, meaning they can realise gains up to this threshold each tax year without paying CGT.

Key Term: Annual Exemption
The amount of capital gain an individual can realise in a tax year without being liable for CGT. This allowance cannot be carried forward if unused. (For 2023/24, this was reduced to £6,000, and further reduced to £3,000 from April 2024).

Revision Tip

The Annual Exemption amount changes frequently. Always check the current rate applicable for the relevant tax year in the SQE1 assessment. The AE is deducted after calculating the gain but before applying the tax rate. Capital losses must be set off against gains before using the AE.

Business Asset Disposal Relief (BADR)

Formerly known as Entrepreneurs' Relief, BADR reduces the rate of CGT payable on qualifying business disposals.

Key Term: Business Asset Disposal Relief (BADR)
A relief that reduces the CGT rate to 10% on qualifying gains from the disposal of certain business assets, up to a lifetime limit (currently £1 million).

Qualifying Disposals for BADR typically include:

• Disposal of the whole or part of a trading business carried on as a sole trader or partner, with ownership for at least two years.
• Disposal of shares in a trading company where, for at least two years before disposal, the individual:
  • holds at least 5% of ordinary share capital and voting rights,
  • is entitled to at least 5% of profits/assets on winding up or 5% of sale proceeds on a disposal of the company (economic test),
  • is an officer or employee of the company or a group company.
• Associated disposals: personally owned assets used in a qualifying business may attract BADR when disposed of in association with a qualifying reduction of the individual’s interest in the business (conditions apply).

Worked Example 1.3

Ben, a higher-rate taxpayer, sells his 10% shareholding in a qualifying trading company, where he has worked as a director for 5 years. He bought the shares for £50,000 and sells them for £250,000. He has made no other disposals this tax year and has his full £1 million BADR lifetime allowance available. Calculate his CGT liability (using the 2023/24 AE of £6,000).

Answer:
Basic Gain = £250,000 − £50,000 = £200,000
BADR applies (qualifying disposal).
Gain after AE = £200,000 − £6,000 = £194,000
CGT Liability = £194,000 × 10% = £19,400
Ben uses £194,000 of his £1 million lifetime BADR allowance.

Other Key Reliefs (Brief Overview)

• Rollover Relief: Allows deferral of CGT on the disposal of qualifying business assets if proceeds are reinvested in new qualifying business assets within a specific timeframe (usually 1 year before to 3 years after disposal). Land and buildings used for trade and certain fixed plant and machinery typically qualify; shares do not. Where only part of the proceeds is reinvested, only part of the gain can be rolled over; any “excess” proceeds may remain immediately chargeable. Deferral operates by reducing the base cost of the replacement asset.

• Hold-Over Relief (Gift Relief): Defers gains on gifts (or sales at undervalue) of qualifying business assets, and certain shares in trading companies, so the donor pays no CGT at the time. The recipient’s base cost is reduced by the held-over gain and they pay CGT on that gain when they dispose of the asset.

• Incorporation Relief: Defers gains when a sole trader or partners transfer a business as a going concern to a company wholly in exchange for shares. If any consideration other than shares is received (e.g., cash), relief is restricted and the gain may be partly chargeable.

Key Term: Rollover Relief
Defers a gain where proceeds from the disposal of qualifying business assets are reinvested in qualifying replacement trading assets within the permitted window, by reducing the replacement asset’s base cost.

Key Term: Hold-Over Relief
Defers a gain on gifts or undervalue transfers of qualifying business assets and certain trading company shares. The transferee’s base cost is reduced by the held-over gain.

Key Term: Incorporation Relief
Defers gains arising on the transfer of a business to a company in exchange wholly for shares. The base cost of the shares is reduced by the deferred gain.

Worked Example 1.4

Partial Rollover. Priya sells a trading warehouse for £600,000, realising a chargeable gain of £180,000 after allowable costs. Within 3 months she acquires a new trading property for £500,000. How much gain can be rolled over and what happens to the replacement asset’s base cost?

Answer:
Only the amount of proceeds reinvested can be rolled over.
Proceeds: £600,000; reinvestment: £500,000; excess proceeds: £100,000.
Maximum rollover = Gain − excess proceeds = £180,000 − £100,000 = £80,000 (deferred).
Immediate chargeable gain = £100,000.
Replacement asset base cost is reduced by deferred gain: £500,000 − £80,000 = £420,000.

Chattels (tangible moveable property)

Chattels are chargeable assets, but generous rules apply for items like antiques and artworks.

• If disposal proceeds are £6,000 or less, the gain is exempt.
• If proceeds exceed £6,000 and the cost was £6,000 or less, a cap limits the taxable gain to 5/3 × (proceeds − £6,000).
• If proceeds are less than £6,000 and the allowable cost was more than £6,000, any allowable loss is restricted to 5/3 × (£6,000 − proceeds).
• Wasting chattels (useful life not exceeding 50 years) are usually exempt unless used for business purposes and capital allowances have been claimed.
• For sets of chattels disposed together, the £6,000 limit applies to the set.

Key Term: Chattels – 6,000 threshold and 5/3ths cap
For tangible moveable property, gains are exempt if proceeds do not exceed £6,000. For proceeds over £6,000 with low acquisition cost, the taxable gain is capped at 5/3 × (proceeds − £6,000). Losses may be similarly restricted if proceeds are below £6,000 and the cost was above £6,000.

Worked Example 1.5

Aisha sells an antique vase for £9,000. She purchased it years ago at a market for £2,000. What is the taxable gain after applying the chattel cap?

Answer:
Proceeds exceed £6,000 and cost ≤ £6,000, so cap applies.
Gain before cap: £9,000 − £2,000 = £7,000.
Cap: 5/3 × (£9,000 − £6,000) = 5/3 × £3,000 = £5,000.
Taxable gain is the lower of actual gain and cap: £5,000.

Private Residence Relief (main home)

Gains on a person’s main residence are generally exempt, provided conditions are met:

• The property has been the individual’s only or main residence during ownership.
• Relief covers periods of actual occupation and certain deemed occupation (for example, the final 9 months of ownership).
• Lettings Relief is limited and only available where the owner shared occupation with a tenant.
• Parts used exclusively for business may not qualify.

Key Term: Private Residence Relief (PPR)
Relief that exempts gains on a person’s only or main residence (subject to conditions), including deemed occupation for the final period of ownership.

Transfers between spouses/civil partners

Assets can be transferred between spouses or civil partners living together on a “no gain/no loss” basis. This does not trigger CGT at the time of transfer; the recipient simply steps into the transferor’s base cost and holding history, enabling tax-neutral transfers for planning.

Key Term: No gain/no loss (spouses/civil partners)
Transfers between spouses or civil partners living together are treated as occurring at no gain/no loss; the transferee takes over the transferor’s base cost and acquisition date for CGT.

Worked Example 1.6

Spouse planning. Tom and Ravi are civil partners living together. Tom holds shares with a large built-in gain and has unused Annual Exemption this year. Ravi is likely to be a higher-rate payer with gains already above the AE. Tom transfers shares to Ravi shortly before a disposal.

Answer:
The transfer is at no gain/no loss, so no CGT for Tom. Ravi takes Tom’s base cost. Because Ravi is already above the AE and at higher rates, the transfer increases overall tax due. If instead Ravi had transferred shares to Tom before disposal, Tom could have used his AE and potentially the lower CGT rate band. The no gain/no loss rule enables tax-efficient reallocation of gains within a couple.

Worked Example 1.7

Residential property surcharge rate. Nina, a basic-rate taxpayer, sells a second home for a gain of £40,000 after allowable deductions. She has £25,000 of unused basic rate band and her Annual Exemption is £3,000.

Answer:
Net chargeable gain = £40,000 − £3,000 = £37,000.
The first £25,000 falls within the basic-rate band and is charged at 18% (residential property), tax = £4,500.
The balance £12,000 is above the basic-rate threshold and is charged at 28%, tax = £3,360.
Total CGT = £7,860.

Exam Warning

Be careful to distinguish between the different reliefs and their specific conditions. For example, Rollover Relief applies to specific qualifying business assets (often excluding shares), while BADR has broader applicability including shares under specific conditions. Hold-Over Relief requires a gift element. Check the special rules for chattels and for a main residence, and remember that market value is used for gifts and connected person transactions.

Losses

If the calculation results in a loss (allowable costs exceed disposal proceeds), this loss can be offset against chargeable gains arising in the same tax year. Any remaining losses can usually be carried forward indefinitely to offset against gains in future tax years. Losses must be offset against gains before deducting the Annual Exemption.

Key points on losses:

• A claim is needed to utilise losses; keep evidence and report the loss to HMRC within time limits.
• Losses on connected person disposals may be restricted (market value applies, but loss relief against gains may be limited if there is no real commercial sale).
• Negligible value claims may be made for worthless shares to crystallise a loss.
• Chattel losses may be restricted by the 5/3ths rule where proceeds are below £6,000 and cost was above £6,000.

CGT rates overview
For individuals, gains not qualifying for BADR are taxed at 10% (basic rate band) and 20% (higher/additional rate), with an 8% surcharge for residential property gains (18%/28%). Gains qualifying for BADR are taxed at 10% up to the lifetime limit.

Key Point Checklist

This article has covered the following key knowledge points:

• CGT is charged on the gain arising from the disposal of a chargeable asset.
• The basic gain is calculated as Disposal Proceeds less Acquisition Cost less Allowable Expenditure.
• Allowable Expenditure includes incidental costs of acquisition and disposal, and qualifying improvement expenditure.
• Market value is substituted for actual consideration on gifts, non-arm’s-length transactions and disposals to connected persons.
• Special rules apply to part disposals and share disposals (same-day, 30-day and s.104 pool matching).
• Key reliefs can reduce or defer the chargeable gain, including the Annual Exemption (AE) and Business Asset Disposal Relief (BADR).
• Rollover Relief and Hold-Over Relief allow for the deferral of CGT under specific conditions related to reinvestment or gifts of business assets; Incorporation Relief defers gains on incorporation when shares are received.
• Chattels: gains are exempt if proceeds do not exceed £6,000; above that threshold the 5/3ths cap may limit taxable gains; some losses are restricted.
• Private Residence Relief (PPR) can exempt gains on a main residence (conditions apply).
• Transfers between spouses/civil partners living together are at no gain/no loss; the transferee takes over the transferor’s base cost.
• Capital losses must be offset against gains before using the Annual Exemption and can be carried forward.

Key Terms and Concepts

• Chargeable Asset
• Disposal Proceeds
• Acquisition Cost
• Allowable Expenditure
• Part Disposal
• Connected Person
• Annual Exemption
• Business Asset Disposal Relief (BADR)
• Rollover Relief
• Hold-Over Relief
• Incorporation Relief
• Chattels – 6,000 threshold and 5/3ths cap
• Private Residence Relief (PPR)
• No gain/no loss (spouses/civil partners)