How does CGT work?

bowlhead99

JuniorG wrote: »

On point (1) I was’t sure which way to do the calc, as in your example: If I buy 100 shares at £1, then 50 shares at £2, as you say the average is £1.33 per share (150/200).

Yes

If I sell the first 25,

If you have 150 of them which cost on average £1.33 each, and you sell 25 of them, you will have 125 left.

Both the 25 shares you sold, and the 125 shares you didn't sell, will have an average cost of £1.33 at that point.

When you sell the 25, you will compare their cost (£1.33 each) to their proceeds (£whatever each) and you will make a gain or loss on those 25 shares. The 125 shares that you haven't sold will stay in your pool, and we know they cost 1.33 each. The average cost of the shares in the pool won't change from 1.33 to some other number unless you buy some more shares and add them to the pool.

If I sell the first 25, then the average of what I have left is actually £1.4 per share (175/125).

Where do those figures come from?

You had 150 shares. They had cost £200 total, so £1.33 each.

If you sell 25 of them (25/150ths of them) they had a cost of 25/150ths of £200, i.e. £33.33. You know this because they were 1.33 each and there were 25 of them, so £33.33 total.

After you sell those 25, the remaining 125 that you have not sold will have a cost of the other 125/150ths of the original £200 cost, ie. £166.67. You can check this because they were 1.33 each and there were 125 of them, so £166.67 total.

So at that point in time, after buying 100 shares and then buying another 50 shares to make 150 shares... then selling 25 shares... the remaining unsold 125 shares definitely have an average cost of £1.33 each and £166.67 total.

You are then going to buy some more shares. You choose to buy 50 more shares at a price of £2.50 each. So you spend £125 on 50 new shares.

The total quantity of shares in the pool goes up from 125, by adding 50 new shares, to 175 shares.

At the same time, the total cost of shares in the pool goes up from from £166.67, by adding the cost of the 50 new shares added, £125, to give you a total cost of £291.67.

So at this point in time you can say you are sitting on a pool of shares containing 175 shares and the total cost of those 175 shares is £291.67. So on average the shares cost £1.67 each, and that is what you will use in gains/losses calculation when you sell some of those shares in future.

At no point do you try to divide £175 by 125 and get 1.4 per share. 175 is the ending quantity of shares resulting from buying 100, buying 50, selling 25, and buying another 50. Whereas 125 was the number of shares you had after the first 3 transactions, and coincidentally also the amount of pounds you spent on buying the 50 shares in the fourth transaction. But there is no reason to divide 175 by 125...?

I think what you’re saying is that, even if I can physically sell the first 25, it doesn’t count as such for tax purposes. I should always carry forward the remaining pooled value and not recalculate the value based on what I specifically have left.

I'm not sure what you mean by physically selling shares and 'it doesn't count as such for tax purposes'...

If you sell 25 shares from one big pool of shares, you reduce the quantity of shares that remain the pool and you also need to reduce the cost of shares in the pool by the cost of what has been taken out. All the shares in the pool are the same, homogeneous, like having a load of boiled sweets or paperclips in a jar. So even though you had bought some of them for £1 and some of them for £2 you end up saying that they cost £1.33 each. When you take 25 of them out of the jar, and you want to know what the remaining ones in the jar cost, it's pretty straightforward.

You have taken 25 items out of the jar, and they cost 1.33 each, and the remaining 125 items still in the jar, still all cost 1.33 each. Removing some paperclips from the jar or shares from the pool doesn't change what the rest of the items had cost each, so you don't need to perform a calculation of 'remaining cost per share' at that point.

But you do need to keep track of the quantity of what is left in the jar and the total cost of the remaining contents of the jar, because in future you will be buying more things to put in the jar, which will change the average price. To know the new average price you will need to add the incremental cost of what you're adding to the jar, to the existing remaining cost of what was already in the jar, to get the total cost of the jar contents. You need to know that total carrying cost of the jar contents, and the quantity in the jar, right before any sale, so you can figure out what cost is attributable to the portion you are selling.

bowlhead99

[quote=[Deleted User];76713246]
I was under the impression that when you sell units, you use the average price. In your example, it's £1.333. However, any remaining units (unsold) remain with that same average price ie fixed until sold completely. [/quote]
If you never buy any more, then yes they will keep that average price until you sell them.

But what you are saying is that if I then were to buy new units, this will alter the average price for what is then the total holding.

But if you do buy some more and throw them into your big imaginary jar of shares on your shelf, the ones at the bottom of the jar won't be locked into that old price forever. The ones at the bottom of the jar are indistinguishable from the ones in the middle or top of the jar.

For example when I bought the first units at £1, they did not get to keep that average cost of £1 each until sold completely. I added some more to the pile of units, the new ones cost £2 each, and that meant I had a bigger pile of units with a different total cost, which worked out at a different average price.

It was not that the ones near the bottom of the pile had a £1 cost and the ones near the top had a £2 cost. When I sell off one of the shares I will just grab one from the pile and they are all functionally the same shares as far as the taxman is concerned, so they are £1.33 each.

That £1.33 won't stay fixed forever if I keep buying new units at some price other than £1.33. Again imagine the £1.33 units are all mixed together at the bottom of the pile and you buy some more at £2.50 to throw onto the pile. The pile is more expensive, on average, per share. When we come to sell shares in the future, we can't decide that we are selling shares that cost £2.50 from the top of the jar, pile or pool, or £1.33 from the bottom.

We are just selling shares from one big general pool, and the logic is the same as when some had cost £1 and some had cost £2. Find out what they had ALL cost and you realise that the mix of (a lot at 1.33) and (a few at £2.50) has an average cost of £1.67 each.

Obviously the average cost of what is in the pot is driven by what proportions were bought at a relatively low or high price. For example if we had 150 shares at 1.33 and we sold 145 of them, we would only have five shares left at 1.33. When we later added 50 shares at £2.50 each, there are a lot more expensive shares than cheap shares. So our average share price of a share in the pot pulled out at random for sale would be much closer to £2.50, and wouldn't be the £1.66 figure we came up with in the other example.

But what you are saying is that if I then were to buy new units, this will alter the average price for what is then the total holding. ie the remaining units after the sale plus the new units. In your example, the new average price becomes £1.67.

Yes

So does that mean that when you do a further sell of the carried forward units which were originally valued at £1.333, you then use £1.67 as the average purchase price.

Yes, because you are not really *just* doing a further sell of the carried forward units which were originally costed at 1.333 ; you are doing a sell of some of your 'pool of shares', and your 'pool of shares' is a mix of some shares which at one point had a cost of 1.333 and some other shares that had a cost of £2.50 or whatever... you can't just 'cherry pick' and say OK I'm just going to sell the ones that I had costed at 1.33 and I'll leave the ones that cost me £2.50 in some other box off to the side.

Some people like the analogy of saying they are all just beans in a jar or peppercorns in a grinder and the average cost of what's left changes as you add more in, but you never know individually when bean is being taken out or which peppercorn is being ground. If I buy petrol at £1.20 a litre and then while there is still some of it left in the tank, I go to the petrol station and buy some more at £1.30 a litre. When I then drive to work the next day and use a litre of fuel, did my petrol cost me £1.20 or £1.30 a litre? I can't tell my car I want a cheap commute today so I'll use up the £1.20 stuff please. It all just cost £1.20something.

[Deleted User]

Bowlhead99 - Thank you very much for your time and patience - you have a really lovely way to explain things in such simple ways. Can you please please explain further another anomaly which is churning in my head. I know the answer is going to be NO and my thinking is completely wrong, but I'd like to understand why..

So... using the above examples, when I buy more units the new average price of the unsold units then becomes £1.66. Great- I understand that. But those units before the sale were valued at £1.33. So when I sell them at a later date and use £1.66 as the purchase price, it would appear that I am making a smaller gain. ie 50*1.33 is less than 50*1.66. So therefore when I subtract the purchase cost (using £1.67) from the sale value, it will give me an apparent smaller gain.

Bowlhead- I know you're going to tell me I lost the plot here, but can you please humour me and explain why this isn't correct.

JuniorG

Many thanks bowlhead99. It’s clear.

You asked, why divide 175/125? That was because my Etrade account shows everything separately. So if I had 100 shares @ £1 and 50 shares @ £2, I can click on the first transaction and sell 25. Etrade then shows I have 75 shares @ £1 and 50 at £2, meaning a purchase price of £175 for 125 shares. But, yes I understand that for tax purposes this doesn’t work as I benefited from the pooling when I sold the initial 25, and what’s left needs to be carried forward at the pooled price irrespective of how Etrade shows them.

One last question if I may? If I gift a volume of shares to my wife, presumably she also considers that she acquired them at the blended cost, and calculates her gain accordingly?

bowlhead99

[quote=[Deleted User];76713562]
So... using the above examples, when I buy more units the new average price of the unsold units then becomes £1.66. Great- I understand that. But those units before the sale were valued at £1.33. So when I sell them at a later date and use £1.66 as the purchase price, it would appear that I am making a smaller gain. ie 50*1.33 is less than 50*1.66. So therefore when I subtract the purchase cost (using £1.67) from the sale value, it will give me an apparent smaller gain.

Bowlhead- I know you're going to tell me I lost the plot here, but can you please humour me and explain why this isn't correct.[/QUOTE]
It's winter. You buy a large bag of salt to grit your driveway to avoid slipping on the ice. 25kg costs you £3 from Wickes. https://www.wickes.co.uk/Tarmac-Meltaway-Rock-Salt-Large-Bag/p/148169

Only 12p a kilo, bargain! Sale ends Monday!

You get the bag home and pour out the contents into a big dry plastic box which you have sitting in your garage. You scatter a big scoopful (about 1.5kg) all over your driveway and path.

You look at the 23.5kg remaining, which cost £2.82 (because the whole 25kg had cost £3.00, and you've already used 1.5kg worth £0.18). It doesn't look as much as you first thought it might, and you fear it will not last very long by the time you've used it at your house and your partner has taken some over to his old nan's house and then your sister's house etc.

So a couple of days later you go out shopping again. Wickes had sold out because their unbelievably cheap price was very attractive and snow has been forecast, there was almost a riot to buy the last bag. So you go to B&Q, and they have sold out of their really big bags because of the mad rush. But they offer small plastic containers at £6.45 for 6.5kg. https://www.diy.com/departments/ezi-melt-de-icing-salt/276971_BQ.prd

Wow, 99p a kilo is expensive. But OK, you'll buy one, because you don't want to be caught short and you are going to have a knee operation in a couple of days time and it will be really inconvenient to go out to the shops in bad weather over the next couple of months if you run out.

So you get the 6.5kg of B&Q salt home, and you want to get rid of the excess packaging so you pour it into the big box in your garage. So now you have 30kg of salt sitting in the garage (23.5kg from Wickes and 6.5kg from B&Q). Lots of little 2-5mm grains. Are you going to count them all? No, what's the point of that. But you know your partner is going to come home and say "bloody ell how much did you spend on this big box of salt?!"

You decide to work it out, and you realise that what's now in the box is 23.5kg costing £2.82 and another 6.5kg costing £6.50. So you can tell him indoors that you spent £9.32 on the 30kg of salt sitting in the garage.

Your partner does come home and ask about the big box of salt. Hmm, he says, scratching his head. 30kg of salt cost us £9.32. My mental arithmetic tells me that's about 31p per kilogram. Yes you say (as you already worked it out with a calculator). I got some of it on a special offer, you say proudly. He nods approval and goes off to make the dinner.

A few days later, the weather forecast is really bad. You are in hospital having your knee operation at this time but your partner is home, and the neighbour sees him gritting the driveway. The neigbour, who your partner doesn't really like, asks if he can 'borrow' some of that salt.

Your partner knows he won't give it back ... but he remembers you had paid about 31p a kilo for the boxful. This stuff doesn't grow on trees, y'know, if you want a couple of kilos it will cost you a pound, says your partner.

Thanks, says the neighbour. A pound for 2kg is great. Are there any particular grains of salt you'd prefer me to take, for my 2kg?

Don't be stupid, says your partner. They are all white 2-5mm grains of salt and a bit of filler mixed in with some anti-caking agent. Just take whichever grains you like! Shaking his head at the idiot neighbour's stupid question. Fine says the neighbour, digs his trowel in and takes 2kg of his choice.

A few days later you get back from hospital, note the bad weather, and ask your partner about the salt supplies.

We're fine, he says. This cold snap will be over soon. I let the neighbour have some. I know you had paid 31p a kilo, so I charged him 50p a kilo. He just dug into our box and paid me a quid for two kilos. We must have made 19p profit per kilo. Haha 38p profit I am a financial genius. Here comes early retirement.

"HOLD ON ONE MINUTE", you say, brain still addled from the anaesthetic and painkillers in your hospital trip.

"I HAD HUNDREDS OF THOUSANDS OF GRAINS OF SALT IN THAT BOX. DID YOU SELL HIM THE SALT GRAINS THAT COST 12P A KILO OR THE ONES THAT COST 99P A KILO ???!!!"

Let's get you to bed, eh. You have lost your damn mind...

The next week your partner goes out and buys more salt. By this point there was only about 20kg left. He buys another 10kg from the store near his work to top up your big plastic box . It costs £4.00 (40p a kilo)

He remembers that you had said that the salt you bought had cost 31p a kilo. So now he has 20kg with average cost of 31p each (£6.20) and 10kg which cost £4. So altogether he has 30kg of salt grains at a cost of £10.20. Dividing £10.20 by the 30kg of salt, he realises that the average cost of the salt in the big plastic box is now 34p a kilo.

If the neighbour comes around and takes another kilo of salt grains taken at random, maybe he will just charge him a quid per kilo this time. Financial Independence, Retire Early! But he knows his costs are going up. The first scoop of salt taken by his neighbour had a cost of 31p a kilo. But the next week, after he's added some more-expensive salt to the box, the average grain of salt costs 34p a kilo. Any 'profit' calculation from now on should be using the 34p figure for its 'cost of sale' - not the outdated 31p figure, and certainly not the even more outdated 12p figure from the very first shopping trip.

bowlhead99

JuniorG wrote: »

...and what’s left needs to be carried forward at the pooled price irrespective of how Etrade shows them.

Yes, you pool it all. Any non-ISA, non-pension accounts, are all one big pool for HMRC (unless you have some separate matching of shares outside the pool for the anti-bed&breakfasting rules mentioned earlier). This is true whether etrade are showing them in separate buckets within one account, or separate accounts, or you have the same shares spread between eTrade and Fidelity and AJBell etc etc.

In some countries, you work on a first-in-first-out basis or a last-in-first-out basis (LIFO or FIFO). In the US, where etrade is headquartered, you track lots and pools separately, so that probably drives the software choice. Over here, since we no longer have taper relief on assets held for a particular length of time, it's just one pool.

One last question if I may? If I gift a volume of shares to my wife, presumably she also considers that she acquired them at the blended cost, and calculates her gain accordingly?

Your transfer to your wife is a no-gain, no-loss transaction and she effectively inherits the base cost of shares, whatever you had paid for them. So the same average that you were carrying in your records. If you were carrying them at 1.33 at the time you transferred them to her, she has acquired them at 1.33. If she later sells them for £4.00, her gain is £2.67 per share, just as if she had paid 1.33 for them herself. Even if she only actually paid you £0.00 for the shares. She could choose to pay more to you than £0.00 if she wanted, but HMRC will always see them as her taking on assets with a cost of £1.33, and you as making no gain or loss in the transfer of those shares.

However, once they are hers - assuming she doesn't transfer them back to you later - they are no longer in your pool, they are in her pool. So when you next acquire some shares, you are only looking at combining the new shares you acquire with what *you* have remaining at that point in time, in *your* pool. The shares (and cost of shares) taken out of your pool and put into her pool are gone, just as if you had sold them.

[Deleted User]

Bowlhead99 - Again, many thanks for your explanation. Not only does it put everything into very clear perspective and in a way that I can follow easily, but I actually enjoyed reading the analogy.

Have you thought about writing a book about investing for beginners - I think you'll make an excellent author and you could make a fortune.

JuniorG

Thank you Bowlhead99. All clear, and immensely helpful. I really appreciate your detailed responses.

Londonlisa12

So average selling price per unit minus average buying price per unit gives me the average profit.

If i divide this in to 12,500 i get how many units i can sell without paying CGT?

Assuming its my only sell of the year.

eskbanker

Londonlisa12 wrote: »

So average selling price per unit minus average buying price per unit gives me the average profit.

If i divide this in to 12,500 i get how many units i can sell without paying CGT?

Assuming its my only sell of the year.

Almost, but the current tax year's CGT allowance is actually £12,000 - you were perhaps mixing it up with the personal allowance.

Also, as per talexuser's earlier post, remember that you can deduct buying and selling costs when calculating your profit.

https://www.gov.uk/tax-sell-shares/work-out-your-gain