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If you sell a valuable item—such as a house, shares, or even a rare collectable—you may need to pay Capital Gains Tax (CGT) on the profit you make. Before calculating your tax, you must determine a key figure: the base cost of your asset. Think of the base cost as the starting line for a race. It is the purchase price of the asset, including extra costs.
What Is Capital Gains Tax?
Capital Gains Tax is a tax on the profit or gains you make if you sell or give away an asset that has increased in value. For example, if you purchase a share for £100 and later sell it for £150, your profit is £50. You’ll pay CGT on that £50 profit. This tax helps fund public services like schools and hospitals.
Understanding the Base Cost
What Does “Base Cost” Mean?
The base cost is simply the original amount you paid for an asset. This is the initial price you use to calculate your profits when you sell the asset. However, the base cost isn’t just the purchase price—it can also include expenses directly related to acquiring the asset.
Why Is the Base Cost Important?
Calculating the base cost correctly is crucial because it determines the amount of CGT you will pay. If you miscalculate or forget to include some costs, you might pay more tax than necessary. On the other hand, properly accounting for all allowable costs can help lower your tax bill. This makes the base cost the foundation for all Capital Gains Tax calculations.
Components of the Base Cost
1. Purchase Price: The purchase price is the amount you originally paid for your asset. This is the most basic part of the base cost. For example, if you bought a property for £200,000, that £200,000 is your starting point.
2. Acquisition Expenses: When you buy an asset, you may incur additional costs. These expenses can be added to your base cost, including:
- Legal Fees: If you hired a lawyer to assist with the purchase, their fees can be included.
- Stamp Duty: A tax paid when buying property.
- Survey Fees: Costs for assessing the condition or value of the asset.
Including these expenses increases your base cost, which can reduce the taxable profit when you sell the asset.
3. Improvement Costs: If you make significant improvements to your asset, you can add these costs to your base cost. For example, if you renovate a house by adding a new kitchen or bathroom, you can include the cost of these upgrades. However, routine maintenance and repairs usually don’t count toward the total cost, as they don’t significantly increase the home’s long-term value.
4. Special Cases: Inheritance: If you inherit an asset, the base cost is not what the previous owner paid. Instead, it is typically the market value of the asset at the time of inheritance. This is often referred to as the “probate value.”
Step-by-Step Guide to Calculating Your Base Cost
Step 1: Gather All Your Documents
Before you start, collect all documents related to the purchase and any improvements made to the asset, including:
- Purchase receipts
- Legal bills and invoices
- Receipts for renovations and improvements
- Records of any additional fees, such as stamp duty or survey fees
Step 2: Record the Purchase Price
Start with the original amount you paid for the asset. This forms the foundation of your base cost.
Step 3: Add Acquisition Expenses
Next, total all the additional costs incurred during the purchase. For example, if you paid £2,000 in legal fees and £3,000 in stamp duty for a house, add these amounts to the purchase price.
Step 4: Include Improvement Costs
If you made significant upgrades, add these costs as well. Only expenses that enhance the asset’s value or extend its useful life should be included. List each expense and total them up.
Step 5: Calculate the Total Base Cost
Now, sum the purchase price, acquisition expenses, and improvement costs. This final total is your base cost, which will be used to determine your capital gain when you sell the asset.
Example Calculation
Let’s say you bought a property for £150,000. You also paid an additional £5,000 in legal fees and £10,000 in stamp duty. Later, you spent £15,000 on significant renovations. Here’s how your base cost would be calculated:
- Purchase Price: £150,000
- Acquisition Expenses: £5,000 (legal fees) + £10,000 (stamp duty) = £15,000
- Improvement Costs: £15,000
- Total Base Cost: £150,000 + £15,000 + £15,000 = £180,000
When you sell the property, your taxable gain will be the sale price minus £180,000 (your base cost), minus any additional selling expenses.
Adjustments and Additional Considerations
Selling Costs
When selling an asset, you may incur costs such as estate agent fees and legal fees. While these are not included in the base cost, you can deduct them from the sale price to reduce your taxable gain.
Points to Remember
Maintaining accurate records of all expenses related to an asset is crucial. If HMRC reviews your calculations, you’ll need to provide evidence for each cost. Omitting legal fees or improvement costs can lower your base cost, resulting in a higher taxable gain and potentially more tax owed. Start with the purchase price and add allowable expenses like legal fees, stamp duty, and renovation costs. Careful record-keeping helps ensure you only pay the tax you owe and avoid unnecessary financial burdens.
