What is Capital Gains Tax ?
Capital Gains tax is a form of income tax accumulated after making profit from assets bought at a cheaper price and sold at higher price. The current Capital Gains Tax in South Africa for individuals is 18%, and 22.4% for companies.
Taxes can impact the growth of your portfolio, so it’s important to understand how capital gains taxes work and learn some strategies to potentially minimize them. Let me note up front that in this article we’re just covering the basics.
Taxes can be complex and vary based on a lot of factors, so it’s always best to consult the South African Revenue Authority (SARS) or a tax professional to understand your specific situation.
How do Capital Gains Tax work?
We’ll start with a simple example. Let’s say you’re an average investor and have a regular taxable brokerage account. You buy a share of stock XYZ for R500.00, and over the course of a year, it increases to R600.00.
At this point, you’ve gained R100.00, but it’s an unrealized gain, because you don’t actually profit until your position is closed.
No matter how long you hold the stock or how much its price changes, you won’t be taxed on gains as long as you don’t close the position and gains remain unrealized. Note that other types of income from stocks, like dividends, may still be subject to taxes, but these may not be considered capital gains.
Now, back to our example. Let’s say you decide to sell the stock at R600.00. That is considered a realized capital gain and is a taxable event.
You now owe SARS on the R100.00 profit. We’re focusing on stocks in this article but be aware that capital gains taxes also apply to other types of investments like real estate, bonds, and mutual funds.
How much is capital gains tax in South Africa?
How is Capital gains tax Calculated in South Africa?
It mainly depends on two factors: how long you held the investment and your income level. There are two types of capital gains: short term and long term. Proceeds from investments you sell after holding for a year or less are generally classified as short-term capital gains.
They are typically taxed at the same rate as your ordinary income, which is determined by the marginal tax bracket you fall into. For reference, marginal tax rates for the 2020 tax year ranged from 18% to 36%, but rates can change over time, so it’s best to check with the SARS for specifics.
Proceeds from investments held for more than a year are typically classified as long-term capital gains. They’re usually taxed more favorably because the South African government views them as providing economic benefit. The specific rate may still vary based on your income, but for reference, the 2020 long-term capital gains rate did not exceed 18% for most people.
Again, rates can change over time, so it’s best to check with SARS or a tax professional. In most cases you report capital gains for the year as part of your annual tax return, which could increase your tax liability when you file. If you realized any gains, it may be a good idea to have money set aside in case you have to pay. Because taxes can significantly impact the performance of your portfolio, it’s important to be proactive in tax planning.
Investment tax planning strategies
- Weigh the pros and cons of short-term investments versus long-term investments. Active investors may attempt to increase returns by quickly buying and selling investments.
However, because of increased taxes and fees, it’s difficult for most people to outperform a well-diversified portfolio of long-term investments that are almost always taxed at a lower rate. When planning your investment strategy, consider how the investment holding period can affect your tax bill.
- Consider maximizing tax-advantaged accounts, like retirement and education accounts. Depending on the type of account, you may be able to buy and sell investments without being subject to capital gains taxes. Reducing your tax burden could potentially help your portfolio grow faster.
- In taxable accounts, make the most of your losses. Benefiting from losses may sound counterintuitive, but SARS actually allows you to write off certain trading losses, which can help offset some of your capital gains taxes.
For example, tax-loss harvesting is a strategy that involves closing certain positions to intentionally realize losses that reduce your tax liability. Many brokerages offer automated tax-loss harvesting services, but it’s not right for everybody, so be sure to check with a tax or financial advisor.
Of course, tax planning and some capital gains calculations can be confusing. That’s why even seasoned investors enlist the help of tax professionals to make sure their taxes are in order.
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