HMSM #05: - Do most investments make money after tax?

In the UK, capital gains tax (CGT) applies to profits made when selling or disposing of an asset that has appreciated since it was acquired. The “gain” is the difference between the purchase price and the selling price. This applies to assets like property, stocks, bonds, and certain valuable items (such as antiques or jewellery) if they exceed a given value.

In most cases, if you make a profit—or “capital gain”—on an asset, you’ll need to pay CGT. The amount owed varies depending on the type of asset and your income tax bracket. Following the 2024 Autumn Budget, the CGT rates are:

• Basic-rate taxpayers pay 18% on gains.

• Higher-rate and additional-rate taxpayers pay 24% on gains.

• For gains on residential property (excluding your primary residence), the rates are higher—18% for basic-rate and 28% for higher-rate taxpayers.

At first glance, paying tax only on the profit might seem reasonable. With the basic income tax rate at 20%, the CGT rate may even appear favourable in comparison. However, this isn’t the full picture.

Inflation and Purchasing Power

Over the past 20 years, the annualised growth rate of the UK money supply has been around 4%, coinciding closely with a 4–5% increase in UK house prices over the same period. This correlation raises a key question: do investors really gain purchasing power over time when their returns only match inflation? Let’s examine two examples to see how CGT affects long-term property investments.

For simplicity, each example assumes the investor pays the basic CGT rate of 18% on their gains.

Example 1: Typical Money Supply Growth

Suppose an investor purchases a £250,000 house as an investment. Over the next 10 years, the pound’s supply grows by 4% per year, and local house prices rise by the same rate. By the end of the 10 years, the house is worth £370,061. When selling the property, the investor owes 18% CGT on the £120,061 gain, resulting in a tax bill of £21,611. This leaves a post-tax profit of £98,450—impressive at first glance.

Yet, while the investor has more pounds than before, the purchasing power of the property didn’t actually increase. It merely kept pace with inflation. After factoring in CGT, the investor’s purchasing power effectively declined over the 10-year period.

In this example, the investor has technically “made money,” but they cannot buy more than before due to the inflationary effects.

Example 2: Higher Money Supply Growth

Now let’s assume the pound’s supply grows by 10% per year, and house prices also rise at this rate. After 10 years, the investment property is worth £648,436. When sold, the investor owes £71,718 in CGT, which leaves a post-tax profit of £326,718. Despite this sizable “gain,” the property’s value merely kept up with inflation. In real terms, the investor’s purchasing power remains stagnant, yet they’re taxed on what is effectively an inflation-driven increase.

Both examples demonstrate how CGT can reduce the real gains on an investment. Since CGT is not adjusted for inflation or money supply growth, investors may “make” money in nominal terms yet lose purchasing power. This highlights an essential distinction in investment: are we aiming simply to increase the amount of money, or to enhance what we can actually buy with it?

Whilst the examples in this article are simplistic, they show that when focusing just on the profit in terms of number of pounds, even a sure-fire investment can leave you with less purchasing power than when you started.

They also show that when money supply growth is high, even owners of scarce assets such as property can lose purchasing power if their assets only match inflation, particularly when taxed on that inflation. The same principle applies to investors in stocks, precious metals, bonds, and other comparable assets if their returns merely keep pace with the growth in money supply.

So next time you’re advised to invest in something because it always “goes up”, it may be worth double checking whether you’ll have more purchasing power at the end of it.

TL;DR: In the UK, capital gains tax (CGT) is paid on profits from selling assets like property, stocks, or valuable items. Basic-rate taxpayers pay 18%, while higher-rate taxpayers pay 24%, with higher rates for residential property gains. Although it may seem reasonable to tax only the profits, the reality is more complex. Over the past 20 years, both money supply and house prices have increased at about 4%, meaning property investments might not significantly enhance purchasing power. Two examples illustrate that even when profits appear high after tax, investors can actually lose purchasing power if asset values simply keep pace with inflation and taxes are applied to those gains. This highlights the distinction between making money and maintaining purchasing power.