Wealthy Maths: Calculate capital gains tax (CGT)

Kristia van HeerdenLatest, Wealthy Maths

There exists a misconception that the capital gains tax (CGT) rate is 18%. While this is sometimes true, your capital gain liability can be far lower. In this post we’ll explain what exactly capital gains tax is, which exemptions apply and, finally, how to calculate and manage your capital gain liability.

What is capital gains tax?

When you sell an asset at a higher price than you paid for it, the profit is called a capital gain. The tax you pay on part of that profit is called capital gains tax. Although this is a special kind of tax, how much you’ll ultimately pay still depends on your income tax bracket.

Your exemption

For each individual, the first R40,000 profit on the sale of assets is tax-free. It’s important to keep in mind this applies only to the profit, which means you have to subtract what you paid (called the base cost) from the price you get.

For example, you bought 1,000 Satrix 40 units at R45 per share. Your purchase price is therefore R45,000. You decide to sell these shares at R52 per share. Your sale price is therefore R52,000. You subtract R45,000 from R52,000 to get to your profit of R7,000. You are liable for tax only on that R7,000, not the full R52,000. Because that profit falls within your R40,000 annual exemption, you aren’t liable for any CGT on the sale.

However, if you made a similar profit on five other sales, all of the profit is added together to get to your total capital gains liability for the year. If you made a R7,000 profit on six different transactions, your capital gain for the year would be R42,000. Your first R40,000 is tax-free, but the remaining R2,000 is taxable. 

Not everything is taxed

In addition to the R40,000 exemption, you do not pay tax on the full amount remaining. Only 40% of the profit after R40,000 is taxed. Read this post to find out how to calculate a percentage. 

If we stick to our example above, you will pay tax on 40% of R2,000, which means you will be liable for CGT on R800.

The profit is taxed at your marginal rate

At this point, you don’t yet know how much tax you have to pay. That amount is only the taxable amount. To get to what you really have to pay, you have to apply your marginal rate. Someone with a marginal tax rate of 18% will therefore pay 18% of R800, which is R144. If your marginal rate were 45%, you’d pay R360. 

Why do people keep saying DWT is 18%?

The 18% figure that most people use as a rule of thumb applies to CGT if you’re in the highest tax bracket.

40% of the profit taxed at a marginal rate of 45% gets you to an effective tax rate of 18%. Don’t believe me? Try it yourself:

0.4 x 0.45 = 0.18

If you wanted to work out your own effective capital gains tax rate, multiply your marginal rate by 0.4, for example:

0.4 x 0.26 = 0.10

How can I use this?

Knowing how CGT is calculated and what the exemptions are allows you to manage your CGT liability yourself. You can control how many assets your sell to stay within your exemption for the year. You can delay selling assets until you stop earning an income, so your marginal rate is much lower.

What are the exceptions?

Assets sold within a tax-free investment account or Regulation 28-compliant product like a retirement annuity (RA) aren’t liable for CGT. That’s wonderful news to those nearing retirement. Your retirement product provider can gradually move your portfolio out of liable assets into cash as you near retirement with no tax implications. 

Wealthy Maths blog

Many of us avoid making financial decisions because we worry that we can’t do the maths. Luckily, there are only a few formulas you need to understand to make a good financial choices. This series of articles is dedicated to helping you understand how to do the calculations for yourself. Once you grasp these simple formulas, you can make better financial choices on the fly.