Investors are failing to use their capital gains tax (CGT) allowance through a lack of understanding of the rules, according to Fidelity International.

CGT is a tax – currently at 18 per cent – on the profit made when selling or disposing of an asset. It applies to stocks and shares, second homes and high value personal possessions such as paintings, antiques and jewellery as well as business assets.

UK taxpaying investors are currently entitled to a CGT free allowance of £10,100 and yet on in three (27 per cent) do not consider CGT relevant to them, according to the latest research from the asset management company.

Paul Kennedy, head of tax and trust planning at Fidelity International, says for those who pay income tax at 40 per cent or higher, the rate of capital gains tax at 18 per cent may look attractive, but the key for most people is to use their tax-free allowance.

He explains, ‘Don’t confuse the two. The rate of tax applies only where a gain exceeds the annual allowance. The annual allowance provides a tax free return whatever the rate of CGT and currently, that’s up to £10,100 of tax free gains per person, per year.’

Using the tax-free CGT annual allowance

Because the annual CGT allowance does not accumulate you cannot just sit back over the years and use all your previous allowances in one go.

To use their annual tax-free allowance investors must realise a gain in that tax-year. This means selling-out of the investment. Previously, many investors used to realise a gain equivalent to the tax-free allowance on the last day of the tax year and then buy exactly the same investment back again at the start of the next tax year.

This so-called 'bed and breakfasting' loophole was closed in 1998, which now effectively means that to use your annual allowance you must wait at least 30 days before re-buying the same investment.

However, while you cannot buy exactly the same investment within 30 days, you can reinvest immediately in a different investment or fund and with many thousands of funds now on offer this strategy is undoubtedly used by some.

There are still two remaining strategies that do allow you to realise a tax-free gain within the annual allowance and then immediately re-purchase the same investment.

The first and most common is where the investor realises a gain by selling the shares or fund and then immediately buys them back within an ISA wrapper (the 30-day rules does not apply where the re-purchase is through an ISA).

The second, over which some caution should be exercised, has the rather unfortunate term of ‘bed & spousing'. In essence, one spouse sells investments to realise a gain within the tax-free allowance and the other spouse then re-purchases an identical investment.