Tax Tuesday: Base cost methods for capital gains

De Wet De VilliersLatest, Tax Tuesday

A while ago, we discussed the basics of capital gains tax (CGT). Most of us contribute to our investment portfolios over time, which means we buy at different prices. In this article we help you figure out the best methods to calculate the base cost of your investment over time.

Remember, when calculating CGT, ‘base cost’ and ‘proceeds’ are important. Base cost refers to the amount you paid for the shares. Proceeds is the amount you receive for selling your shares.

To determine the base cost of shares, taxpayers can use one of three alternative methods. These are:

  1. Specific identification 
  2. First-in-first-out (FIFO)
  3. Weighted average

Let’s use an example to illustrate the difference in methods we’re going to use.

You bought the following shares in a company listed on the JSE:

  • Bought: 175 shares at R95 per share
  • Bought: 125 shares at R105 per share
  • Sale 1: Sold 150 shares at R116.50
  • Sale 2: Sold 75 shares at R116.50
  • Bought: 205 shares at R122.50 per share
  • Sale 3: Sold 65 shares at R125

Specific identification

The cost of each share disposed of is separately identified. This could be a reference to share certificate numbers or the date of acquisition and cost. This means that the taxpayer can pick the shares with the highest base cost to be sold.

First-in-first-out (FIFO)

Here it’s assumed that the shares which are held for the longest period of time are sold first.

Weighted average

An average unit cost is calculated every time shares are bought.. This is done by adding the cost of the newly acquired shares to the cost of the existing shares and dividing this figure by the new total number of shares held.

The weighted-average method may only be used for shares listed on a recognised exchange. If it was used in respect of listed share and that share became unlisted, the weighted-average method can no longer be used. Once one of these methods has been used for a specific listed share, the taxpayer must continue to use that method until those shares are sold.

Now you need to determine the base cost under each option – remember, you’re looking for the highest base cost.

Considering all options, FIFO may be the easiest to apply. However, many taxpayers use the weighted-average method as that is typically what collective investment schemes and finance houses use when providing you with your IT3(c).

Irrespective of the method used –  please ensure that your choice and calculation can be supported.

Tax Tuesday blog

Being tax efficient is an important part of great financial management. In this blog, a group of South African tax experts share their tips and explanations on tax issues. Learn everything you need to know about tax, from deductions you never knew about to retirement savings and capital gains. The first Tuesday of every month is Tax Tuesday. Don’t miss it!