Daily Equity Report
Seed Weekly - Making use of the CGT Exclusion
A while back I had an interesting conversation with a friend. Every year she sells a portion of her unit trust investments and then immediately reinvests the proceeds into the same fund. Her rational behind this is that every year SARS provides you with Capital Gains Tax (CGT) exclusion and you can use this exclusion to increase the base cost of our investment and reduce your future CGT liability.
How are capital gains calculated?
You make a capital gain if you dispose (sell) and asset for more than the original price (base cost). A simple example is:
• Invest R 1 000 into a unit trust
• Sell the unit trust for a total value of R 1 700.
So can you actually decrease your future CGT by selling a portion of your investment and reinvesting it immediately?
For ease of calculation I have made the following assumptions:
• The investment is a unit trust.
• The returns of an average equity unit trust are used.
• There are no transaction costs.
• One is able to sell and buy the exact same unit trust on the same day.
• Distributions and reinvestments by the unit trust are not taken into account.
I did the calculation on the different sizes of initial investments. Every year you sell a portion of your investment where the CGT is equal to that tax year’s exclusion. In 2006 the exclusion was R 10 000, this tax year it’s R 30 000.
The chart below illustrates how the base cost increases every year for the different portfolios compared to the unit price of underlying investment and base cost of not selling.
You derive the biggest benefit when the portfolio is smaller. The new base cost is calculated using the weighted average of the previous year’s base cost and the price of the “new” investment. With a smaller portfolio you are able to sell a higher ratio of the units and increase the base cost more effectively.
The graph below shows the unrealised capital gains (The capital gains you would make if you were to sell 100% of your portfolio.) for the different portfolios at the end of the 8 year period.
With a R100,000 portfolio it was possible to reduce the unrealised capital gains by 98%, with the R500,000 portfolio by 23% and the R1,000,000 by 12%.
By increasing the base cost of the investment in line with the current price of the unit trust you are able to reduce the unrealised capital gains on the investment and ultimately your CGT liability when making a full disposal of the investment.
This is a very simplistic discussion about how to reduce your CGT liability and makes quite a few assumptions. In reality we would guess that the benefit wouldn’t be as great as illustrated. This strategy would also require a very disciplined investor to put the trades through timeously each year and reinvest the full proceeds from the disposal. It is also very evident that the benefits of this strategy reduce as your portfolio grows.
Tue, 03 Dec 2013- 12:16
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