Tax is not normally something that is on your mind when you are thinking about a separation or divorce but divorce solicitors say that capital gains tax has to be considered when negotiating a divorce financial settlement.
The government has announced changes to the way capital gains tax is calculated on separation or divorce. In this article, divorce financial settlement solicitor, Robin Charrot, looks at the planned changes and explains the importance of checking out tax on divorce before you agree to your divorce financial settlement.
Tax on divorce
Many people who decide to separate do not realise that the timing of their separation, or their decision to transfer assets to the other spouse or to sell assets, can create tax implications. That is why it is important that a divorce financial settlement solicitor checks any proposed financial agreement to both reality test the financial settlement and to check the net effect of the financial deal. Without legal input, what you think is an equal split may not be a 50:50 division of assets if one spouse is going to end up paying a large tax bill in the future, whilst the other spouse escapes from tax liability. The financial agreement may still be a fair financial settlement but both husband and wife must understand the net effect so they are both comfortable with the deal or can negotiate a financial settlement that does achieve equality if that is their objective.
The current tax rules on separation and divorce
Under the current tax rules, a husband and wife can transfer assets between one another without the transfer is taxable. That’s because the transfer of an asset takes place on a no gain and a no loss basis so the spouse acquiring the asset gets the item at the base cost of the spouse who is transferring the asset to them. In other words, a spouse transfer does not crystalise a gain or loss. The issue with the current tax rules for separating couples is that these capital gains tax rules only give these concessions in the tax year of separation.
That may not sound like a big problem but it is. Take the example of a couple with an investment portfolio or a buy-to-rent property. They may conclude that if the wife is to stay in the family home, then the fair financial settlement is for the wife to transfer her share of the investments or buy to let property to the husband. If the couple decides to split in late March they only have until the end of the tax year in early April to sort out the transfers. If they don’t then one of them could face an unexpected and large capital gains tax bill that they would be solely responsible for.
Even if a couple decides to separate in May (so they have almost a full tax year) they can get caught out if they do not take early legal or accountancy advice. For example, the couple could start no-fault divorce proceedings in June but not start thinking about their divorce financial settlement until many months later giving them insufficient time to give notice to transfer investments or to sort out a new mortgage on the buy-to-rent property before the end of the tax year of separation.
The government has acknowledged that tight timeframes on various tax aspects arising from separation or divorce can create difficulties and complexities so the proposed new tax regime is more generous and less restrictive.
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The changes to tax on divorce or separation
With effect from the 6 April 2023, there will be a new tax regime for separating or divorcing couples. If you transfer assets between spouses on or after the 6 April 2023 the no loss and no gain principle will apply to transfers that take place up to 3 years after the end of the tax year of separation. Furthermore, if the transfer takes place as part of a financial court order there is no time limit for the no loss and no gain principle.
The changes to tax on divorce or separation and the family home
If you sell or transfer a family home as a married couple there is no capital gains tax payable because of principal private residence relief. However, principal private residence can be lost resulting in unexpected tax bills.
The complexities of capital gains tax mean you both need to think carefully through the ramifications of agreeing to a mesher order on the family home. For example, a husband and wife may agree that the family home should stay in joint names until their youngest child is 18 as the spouse staying in the family home can’t afford to take out a mortgage in their sole name so cannot get the house transferred to them. In reaching this type of mesher agreement the spouse who leaves the family home can, in some circumstances, lose their principal private residence relief.
The government is planning to make it simpler for couples to agree to mesher orders because the non-occupying husband or wife’s share of the property will not be subject to CGT when the family home is eventually sold under the terms of the mesher order. The proposed changes may make mesher-type orders more attractive to some families, especially where there isn’t enough equity to rehouse two families or there is a particular need to delay selling the family home until the children have completed their exams.
Capital gains tax and divorce in the future
Even after the new rules come into force capital gains tax will still be payable in some scenarios when a couple separates or divorces. If you are concerned about reaching a divorce financial settlement and the tax implications it is best to get early specialist advice on your family law options.