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Defuse capital gains using Bed & ISA?

Practical Issues
TheDrop
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Defuse capital gains using Bed & ISA?

#21188

Postby TheDrop » January 8th, 2017, 2:15 pm

Previously I topped up my Stocks & Shares ISA using fresh cash that had not been invested before. It occurred to me that since I have a taxable shares account, it would be more tax-efficient to do the following:

At the start of the new tax year, "Bed & ISA" a slice of taxable assets with capital gains below the CGT allowance. New money will top up the taxable account instead of the ISA so this process can be repeated in future years.

("Bed & ISA" means selling in the taxable account, transferring the proceeds into the ISA, and immediately buying back the same assets inside the ISA. Many brokers support this process to make it fast and reduce the risk of market movements.)

This defuses capital gains because when you buy Cost Basis increases by X, but when you sell Cost Basis decreases by Cost Basis * Remaining Value / (X + Remaining Value).

For example, start with Cost Basis=1 and Remaining Value=2, a 100% capital gain. We add X=1 to the portfolio and then Bed & ISA brings Cost Basis to 1.33 instead of 1. Therefore we've defused the capital gain down to ~50%. This example uses silly numbers but shows that the math works.

By moving money from the taxable account into the ISA it is possible to take advantage of (part of) the CGT allowance each year. This approach is less aggressive than managing capital gains by selling and re-buying within the taxable account (mindful of the 30-day rule) but it's easier to implement.

Trading costs are negligible: one extra buy + sell per year.

Any thoughts on using this approach every year? Alternative recommendations for managing capital gains in a taxable account?

kempiejon
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Re: Defuse capital gains using Bed & ISA?

#21193

Postby kempiejon » January 8th, 2017, 2:34 pm

I do something pretty similar. In fact from about now I keep an eye on my holdings in the taxed accounts, or set limit orders for likely opportune sales to save me making forced decision early April. I'll sell realising profits up to the limit (or if need be balance with losses) over the next couple of months and as soon as April 7th rolls along I'll move the cash into the ISA. This doesn't stop me adding new money to the unsheltered accounts or buying in this period.

Lootman
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Re: Defuse capital gains using Bed & ISA?

#21238

Postby Lootman » January 8th, 2017, 4:23 pm

By doing a "bed and ISA" at the start of a tax year, and using up your annual CGT allowance then, you are at the mercy of a corporate action later in the tax year forcing a gain on you that takes you over the CGT allowance.

To avoid that you can perform this process at the end of the tax year, when you know whether any gains have been forced into you. But to do that you would probably want to sell the shares in your taxable account and then make a cash subscription to your ISA, rather than moving the shares over.

In any event, if you move a share position from a taxable account to an ISA, it will be sold and re-purchased anyway, along with the costs, although your broker may give you a break of the commissions. TDDI does anyway.
Last edited by Lootman on January 8th, 2017, 4:37 pm, edited 1 time in total.

dspp
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Re: Defuse capital gains using Bed & ISA?

#21248

Postby dspp » January 8th, 2017, 4:44 pm

Can I ask a clarification question please ? It seems the be answered in what is below but I'd like to be sure.

Assume I have (say) £11k taxable gains on an unsheltered share that I bought for (say) £9k, i.e. it has roughly doubled in value and is now worth £20k. Is it permissible to sell that share to cash in late March (thereby using the 2016/17 CGT allowance of £11k) and in early April, after the tax year opens on 5th April, transfer the £20k cash into my ISA, then buy the same share for (hopefully) the same price inside my ISA thereby using up the full 2017/18 ISA allowance.

If this is OK then it has the advantage of a) using the 2016/17 CGT allowance neatly and b) minimising the time out-of-the-share (which otherwise needs to be 31+ days). The other way would be to sell that share in late Feb and park the money either in cash or in a proxy share (that hopefully moves in a similar way).

(I understand Lootman's point re losing out on ISA flexibility for the remainder of the year, for example to deal with corporate actions, but that is less of a concern for me).

regards, dspp

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Re: Defuse capital gains using Bed & ISA?

#21252

Postby swill453 » January 8th, 2017, 4:48 pm

Snorvey wrote:If you have a husband/wife, open an account for him/her too. A transfer of shares to effect a 'bed and spouse' is a useful way to utilise all your available CGT allowances. Halifax/BoS take up to 10 working days to transfer holdings for example.

Be careful. A "bed and spouse" has to be a sale by one on the market, and repurchase by the other. A direct transfer between them won't work.

Scott.

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Re: Defuse capital gains using Bed & ISA?

#21259

Postby swill453 » January 8th, 2017, 5:08 pm

Snorvey wrote:So if (say) spouse A has fully used up a CGT allowance and spouse B has a CGT allowance remaining, a transfer of shares from A to B to sell and to utilise B's remaining CGT allowance won't work? (I'm actually thinking of doing this with SKY shares btw).

Yes I think that would work, though I'm no expert.

(But it's not "bed and spouse", obviously.)

Scott.

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Re: Defuse capital gains using Bed & ISA?

#21291

Postby Lootman » January 8th, 2017, 6:20 pm

dspp wrote:Assume I have (say) £11k taxable gains on an unsheltered share that I bought for (say) £9k, i.e. it has roughly doubled in value and is now worth £20k. Is it permissible to sell that share to cash in late March (thereby using the 2016/17 CGT allowance of £11k) and in early April, after the tax year opens on 5th April, transfer the £20k cash into my ISA, then buy the same share for (hopefully) the same price inside my ISA thereby using up the full 2017/18 ISA allowance.

Yes, the 30 day rule doesn't apply if you are buying in an ISA and selling in a taxable account, or vice versa.

dspp wrote:(I understand Lootman's point re losing out on ISA flexibility for the remainder of the year, for example to deal with corporate actions, but that is less of a concern for me).

Actually I don't think you do understand my point because that wasn't it!

I was essentially suggesting the same thing as described in your paragraph above. My reference to corporate actions was to do with one's taxable account and how they can force you into gains after you have already used up your cGT allowance. If you wait until late March (or even very early April) then that risk is avoided.

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Re: Defuse capital gains using Bed & ISA?

#21300

Postby dspp » January 8th, 2017, 6:39 pm

Sorry Lootman, I probably only said half of what I should have. Doing it the way I am proposing would use up my 2016/17 CGT allowance and all my 2017/18 ISA allowance. You are quite correct it would leave my 2017/18 ISA allowance untouched. Thanks for your response which is helpful. Now to pay careful attention to ex-div dates !

regards, dspp

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Re: Defuse capital gains using Bed & ISA?

#21702

Postby Gengulphus » January 9th, 2017, 10:03 pm

TheDrop wrote:At the start of the new tax year, "Bed & ISA" a slice of taxable assets with capital gains below the CGT allowance. New money will top up the taxable account instead of the ISA so this process can be repeated in future years.

("Bed & ISA" means selling in the taxable account, transferring the proceeds into the ISA, and immediately buying back the same assets inside the ISA. Many brokers support this process to make it fast and reduce the risk of market movements.)

This defuses capital gains because when you buy Cost Basis increases by X, but when you sell Cost Basis decreases by Cost Basis * Remaining Value / (X + Remaining Value).

For example, start with Cost Basis=1 and Remaining Value=2, a 100% capital gain. We add X=1 to the portfolio and then Bed & ISA brings Cost Basis to 1.33 instead of 1. Therefore we've defused the capital gain down to ~50%. This example uses silly numbers but shows that the math works.

By moving money from the taxable account into the ISA it is possible to take advantage of (part of) the CGT allowance each year. This approach is less aggressive than managing capital gains by selling and re-buying within the taxable account (mindful of the 30-day rule) but it's easier to implement.

As a general comment on this, two of the three parts of the "bed & ISA" have no CGT consequences at all, namely the cash transfer into the ISA and the purchase within the ISA. So for CGT purposes, a "bed & ISA" is nothing more or less than a sale outside the ISA.

In particular, you can achieve the CGT effect you describe without involving the ISA at all. E.g. suppose you have a holding worth 2 and with a cost basis of 1 outside the ISA. Buy X=1 outside the ISA late one day and you now have a holding worth 3 and with a cost basis of 2. Either sell a part X=1 or bed-and-ISA it the next day and you're left with a holding worth 2 (plus or minus normal market movements) and with a cost basis of 1.33. It does have to be the next day (or later) - if it's the same day, then the same-day rules match the buy and the sale (or sale part of the "bed & ISA") up with each other. (And just in case anyone is confused about the point, the 30-day rule is about buys following sales within 30 days - it doesn't catch sales following buys within 30 days.)

The manoeuvre defuses the unrealised capital gain down from 2-1 = 1 to 2-1.33 = 0.67, i.e. by ~33%, not ~50%.

The alternative of selling X=1 and then buying X=1 the next day instead first reduces it to a holding worth 1 with a cost basis of 0.5 and then increases it to a holding worth 2 with a cost basis of 1.5. That does defuse the unrealised capital gain by ~50%, so as you indicate, that alternative is more 'aggressive' - but runs into problems with the 30-day rule, making it necessary to wait until at least the 31st day after the sale to do the buy.

All of the above assumes the buy and the sale are of the same type of share and done by the same "person": if they involve different types of share or are done by different "people", the requirements to wait vanish - and the advantage that an ISA gives one is essentially that it's a different "person" from oneself (and of course, one that is exempt from CGT and Income Tax!).

The point of all this is that one basically needs for CGT planning purposes to work out what buys and sales one wants to make, and then to look at how (if at all) to do the sales as parts of "bed & ISAs" to (a) do buys and sales of the same share closer together while still getting the desired CGT effect; (b) exploit any commission reductions the broker gives for a "bed & ISA" over a separate sale and buy. Those last two are generally very small effects except in the case of being single and wanting to do the buy after the sale, i.e. to adopt the more 'aggressive' approach.

I.e. basically, while the approach you describe works, doing it with a buy followed by a "bed & ISA" is likely to be only slightly different in value from doing it with a buy followed by a sale. And doing it with a buy followed by a "bed & ISA" has the potential conflict between wanting to do the ISA subscription early in the tax year to maximise the time that your investments are tax-sheltered but wanting to do the CGT-planning buys and sales late in the tax year, when the danger of having unexpected gains and losses realised by takeovers in that tax year has passed.

Gengulphus

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Re: Defuse capital gains using Bed & ISA?

#21734

Postby Alaric » January 10th, 2017, 12:38 am

Gengulphus wrote: And doing it with a buy followed by a "bed & ISA" has the potential conflict between wanting to do the ISA subscription early in the tax year to maximise the time that your investments are tax-sheltered but wanting to do the CGT-planning buys and sales late in the tax year, when the danger of having unexpected gains and losses realised by takeovers in that tax year has passed.


The simple minded solution is to sell enough on the 4th April or earlier to utilise what remains of your CGT Allowance and to raise enough for the next year ISA subscription. You hold cash over the end of tax year and transfer and purchase in the ISA from 6th April onwards.

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Re: Defuse capital gains using Bed & ISA?

#21845

Postby paulnumbers » January 10th, 2017, 1:04 pm

Gengulphus wrote: (And just in case anyone is confused about the point, the 30-day rule is about buys following sales within 30 days - it doesn't catch sales following buys within 30 days.)


Wow, this is an incredible "loophole" in the system. Very useful indeed. Thanks.

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Re: Defuse capital gains using Bed & ISA?

#21881

Postby Lootman » January 10th, 2017, 3:51 pm

paulnumbers wrote:
Gengulphus wrote: (And just in case anyone is confused about the point, the 30-day rule is about buys following sales within 30 days - it doesn't catch sales following buys within 30 days.)

Wow, this is an incredible "loophole" in the system. Very useful indeed. Thanks.

I'd phrase the situation a little differently. The way it is stated assumes that a buy opens a position and a sale closes it. But that is not always the case. You can sell a security first and buy it back later (going short). In that case the 30-day rule applies if you re-sell the security within 30 days of buying it back. But doesn't apply for the initial buy back.

Many investors don't sell short in which case the distinction isn't material. But particularly if you use options, then selling before buying is fairly routine. So personally I prefer to talk about opening and closing a position than to assume it's always a buy followed by a sell.

Also, I'm not sure I'd call it a loophole. The UK tax system no longer accounts for how long you have held a position. Indexation was abolished a number of years ago, and we don't have different rates of CGT for short-term and long-term holdings, as the US system does. So it entirely makes sense that the 30-day rule doesn't apply to a buy followed by a sell - the buy doesn't establish a gain or a loss and the holding period doesn't affect anything.

The real loophole, in my opinion, is that you can sell one security and buy a near identical holding the same day, and not fall foul of the 30-day rule. So you could, for instance, sell a FTSE-100 index fund and buy one from a different issuer and, to the best of my knowledge, get away with it. (If you are paranoid, then sell a FTSE-100 index and buy a UK All-Share index fund. They are close enough).

You can also sell a share and buy options to replicate the position. After 31 days, sell the option and buy back the share. You get to take the gain or loss, while maintaining your exposure.

If I ran HMRC I would change the 30-day rule to say that you cannot buy a "substantially similar" security within 30 days.

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Re: Defuse capital gains using Bed & ISA?

#21900

Postby Alaric » January 10th, 2017, 4:24 pm

Lootman wrote:
If I ran HMRC I would change the 30-day rule to say that you cannot buy a "substantially similar" security within 30 days.


It would make lawyers extremely happy being paid large fees to establish what "substantially similar" actually meant. As a for example is an OIEC in any shape or form substantially similar to an ETF? Even within OIECS or ETFs there are funds that track indexes by replication and others that do it by sampling.

There's never been a proposal that individuals be taxed on a "mark to market" basis, putting a levy on unrealised gains. Whilst attractive in acting as a sort of wealth tax proxy, it has the disadvantage to revenues from such a tax would disappear and even go negative if there were a market download.

Life assurer holdings of collective funds have been taxed that way for twenty years or more.

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Re: Defuse capital gains using Bed & ISA?

#21903

Postby TedSwippet » January 10th, 2017, 4:35 pm

Lootman wrote:The real loophole, in my opinion, is that you can sell one security and buy a near identical holding the same day, and not fall foul of the 30-day rule.

Loophole? No, the real issue is that the 30-day rule is nonsense that has no business existing. :-)

Everyone has an annual capital gains allowance granted by the government. Why is using it seen as more objectionable than using the annual pension allowance, annual tax free allowance, annual ISA allowance, and so on? The 30-day rule merely places an unwanted (and ineffectual!) obstacle in the way of using a legitimate allowance.

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Re: Defuse capital gains using Bed & ISA?

#21917

Postby paulnumbers » January 10th, 2017, 5:23 pm

TedSwippet wrote:
Lootman wrote:The real loophole, in my opinion, is that you can sell one security and buy a near identical holding the same day, and not fall foul of the 30-day rule.

Loophole? No, the real issue is that the 30-day rule is nonsense that has no business existing. :-)

Everyone has an annual capital gains allowance granted by the government. Why is using it seen as more objectionable than using the annual pension allowance, annual tax free allowance, annual ISA allowance, and so on? The 30-day rule merely places an unwanted (and ineffectual!) obstacle in the way of using a legitimate allowance.


No argument from me here.

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Re: Defuse capital gains using Bed & ISA?

#21922

Postby Lootman » January 10th, 2017, 5:32 pm

Alaric wrote:
Lootman wrote:If I ran HMRC I would change the 30-day rule to say that you cannot buy a "substantially similar" security within 30 days.

It would make lawyers extremely happy being paid large fees to establish what "substantially similar" actually meant. As a for example is an OIEC in any shape or form substantially similar to an ETF? Even within OIECS or ETFs there are funds that track indexes by replication and others that do it by sampling.

There is a model for this. The US CGT system has a "wash sale" rule that operates on that basis. It's only where a security is sold at a loss, however, since there is no annual CGT-free allowance in the US. Like here, there is a 30 day wait period.

I believe that a "substantially similar" security is defined in fairly precise ways so that it doesn't lead to endless litigation. It covers index funds in the same index or an index that is 80% or more similar. It includes in-the-money put and call options on the underlying. It includes some kinds of straddle transactions that can be used to create artificial gains and losses, and so on.

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Re: Defuse capital gains using Bed & ISA?

#21950

Postby TedSwippet » January 10th, 2017, 7:02 pm

Lootman wrote:I believe that a "substantially similar" security is defined in fairly precise ways so that it doesn't lead to endless litigation.

The actual term the IRS uses is "substantially identical". It has never been defined at all, either loosely or precisely.

The IRS is happy to tell you what it thinks for a given one-time case, though it will charge you a mere $2,700 for the privilege.

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Re: Defuse capital gains using Bed & ISA?

#22041

Postby TheDrop » January 11th, 2017, 8:08 am

Thanks for the feedback!

Gengulphus: Great insight about the plain "buy followed by a sell" technique.

Snorvey: "Bed and spouse" is more effective than "bed and ISA" because it's unconstrained by the yearly ISA contribution limit and therefore allows taking advantage of the full CGT allowance. Unfortunately it's not practical all everyone, even those with a spouse trusted in financial matters.


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