Breaking up can be hard to do especially with no tax costs! Divorcing is complicated in itself, let alone trying to navigate your tax position.
When a marriage or civil partnership ends, tax is probably the last thing that the separating couples want to think about. However, seeking specialist advice early on in the separation process could prevent an unexpected Capital Gains Tax (CGT) liability from arising.
We have put together some important tax implications to consider when divorcing or separating.
Transfer at ‘No Gain/No Loss’
One of the greatest CGT benefits that spouses and civil partners have, is the ability to transfer assets between each other on a ‘no gain/no loss’ basis, provided that they are ‘living together’ at some point in the tax year of separation. The definition of ‘living together’ can be complex but basically, a couple will be treated as such unless they are separated under a court order, formal deed of separation or unless the separation is permanent.
This means that assets can be transferred without incurring CGT, therefore at a value that will give rise to neither a gain nor a loss. When the transferee comes to dispose of the asset, their base cost is the same as the base cost that would apply to the person making the transfer.
Transfer of matrimonial assets at this point without any CGT consequences could maximise the funds that are available to be divided between the separating couple.
Transfer at market value
If the tax year when the couple separated has ended then any transfer of assets after this date will be deemed to take place at market value, as the separating spouses are classed as ‘connected persons’ (provided that this is before the decree absolute has been issued). In this situation, the separating couple could be faced with an expected CGT cost and in some cases, there may be no funds available to meet the liability.
In some cases, the market value rule could create a capital loss. Losses arising on assets transferred after the year of separation but before the decree absolute are known as ‘clogged losses’ whereby they can only be offset against gains on transfers to the same connected person. An important planning point where there is likely to be a transfer of multiple assets is to try and balance any assets transferred at a loss with those transferred at a gain. This could mitigate any CGT liability and utilise any capital losses which would be lost after the issue of the decree absolute as the spouses will no longer be connected.
Transfer at arm’s length
Once the decree absolute has been issued and the divorce finalised, the divorced couple is thereafter treated as ‘unconnected persons’ and the market value rule no longer applies. Any transactions after this date will take place on an arm’s length basis as divorced couples are now considered independent of each other. Transfer of the asset will now take place for actual consideration (if any) although the date of disposal needs to be reviewed as this can vary depending on the timing of the court order and the decree absolute.
The matrimonial home
Generally, any gains arising on the family home will be exempt from CGT if the couple have lived in the property throughout its period of ownership. This is exemption is known as private residence relief (PPR), however, the position may change if one spouse moves out of the family home and rents or buys another property.
PPR is available for 9 months after one of the couple has moved out of the family home and therefore any gain arising after the 9 month period will not benefit from the PPR exemption, although in some cases and subject to certain conditions the 9 month period may be extended.
In conclusion, it is vital for the separating couple to get timely advice to prevent them from having an unexpected CGT liability that they may struggle to afford.