Divorce

Capital Gains Tax for Divorcing Spouses: Improvements in the Law

Many readers will already know that when an asset is transferred from one individual to another, the transferring party may have to pay capital gains tax (CGT) if the market value of the asset being transferred is higher than the value for which the asset was acquired – i.e. there is a gain in value. This is the case even when the transfer of the asset is a gift.

However, the transfer of assets between married couples does not attract CGT. This is a situation that may change if a couple separates but remains married, and is relevant while the couple is going through divorce proceedings.

In March 2023, the government introduced legislation (Finance (No. 2 Bill) 2023) to improve the CGT position of divorcing couples. The legislation, which came into effect from 6 April this year and received Royal Assent on 11 July, means that couples now have a longer period to agree a financial settlement and transfer of assets between themselves, without facing unwanted CGT consequences. In addition, amendments have been made to improve the CGT position where couples agree, or court orders, to defer the sale of the family home to a later date.

background

In March 2021, we reported on the unfair CGT situation some couples may find themselves in after separating (It’s all in the timing: the family home and capital gains tax upon divorce). Before 6 April 2023, divorcing spouses had to transfer assets during the tax year of separation to avoid paying CGT when assets were transferred. This means that if they separate on 1 April 2022, they will have four days to transfer assets between them or face a potential CGT bill, while a couple separating on 6 April will have 364 days to transfer assets.

In May 2021, we also reported that the Office for Tax Simplification (OTS) had proposed reforms to this legislation in its report on CGT (What after the capital gains tax? Part Two: The Office for Tax Simplification recommends targeted reforms). The government approved their proposals and on April 6, 2023, amendments were made to the legislation.

How long do spouses now have to transfer assets between themselves?

Divorcing couples now have three tax years after the tax year in which they separate to transfer assets between each other without facing a CGT bill, rather than having to transfer assets during the tax year of separation.

However, spouses should be aware that if their divorce is finalized, before the end of the three-year period, their ability to make transfers on a no-profit-no-loss basis ends. For this reason, it is essential that couples with assets that would attract CGT upon transfer seek appropriate legal advice before finalizing their divorce.

Where transfers are made in accordance with a formal divorce agreement or court order, CGT is not charged provided any disposition is made in accordance with that agreement.

Caroline East, Senior Fellow in our Family Department comments: “The previous law had potentially devastating financial effects on families in terms of having enough money after a divorce. Sometimes this could be in cases where the amount of equity in a second property (if left as is) has made a huge difference in terms of successful rehousing for both parties after divorce.Alternatively, divorcing spouses could inadvertently lead to an immediate and debilitating CGT liability through the timing of their separation, thus depleting the amount of capital available for rehousing. Housing automatically The government’s assistance to separated couples manage their finances in a tax-efficient manner after a relationship breakdown is a long overdue and very welcome development.

family house

In divorce proceedings, negotiations often center around the family home, which can be the most valuable and emotional asset. Family home relocations often attract a special CGT benefit known as the Principal Private Residence Benefit (PPR). This exemption enables individuals to move or sell their principal home without paying CGT on any gains made. PPR is available only when the property in question is the individual’s primary residence and is occupied, except for certain limited conditions.

The amendments described above (extending the period in which spouses can transfer assets between themselves without CGT consequences) may mean there is no CGT to pay when transferring the family home between divorcing spouses. However, the situation is different when the property is sold to a third party and one of the parties no longer lives in the family home.

Recent amendments to the legislation address those circumstances in which spouses cease to live together and the spouse, who leaves the family home, is entitled, by agreement or court order, to a share of any profit made when the property is subsequently sold. The later date could be, for example, when the youngest child of the couple turns 18, which would be many years after the transfer took place.

The modifications will benefit the non-occupying spouse if gains are made on the disposal of the family home because they can still claim the PPR exemption, even though the PPR benefit requirements are not met for occupation of the property.

If the non-occupying spouse ceases to hold an interest in the family home, but retains the right to receive a share of the proceeds when the property is sold, a PPR waiver can be claimed with respect to the amount received if:

  1. Immediately before the non-occupier spouse leaves the family home, the property is his or her sole or principal residence;
  2. the unoccupied spouse relinquishes his interest in the family home to the surviving spouse;
  3. Such interest shall be disposed of by the surviving spouse in accordance with a formal divorce agreement or court order.

If the non-occupying spouse retains an interest in the family home and subsequently disposes of that interest to a third party, different conditions apply:

  1. Immediately before the non-occupying spouse leaves the family home, it must be his sole or principal residence;
  2. The sale proceeds that the unoccupied individual receives upon disposition of the family home must be received pursuant to a formal divorce agreement or court order;
  3. In the period between the non-occupier ceasing to live in the family home and ceding his or her interest in the family home to a third party:
    • The home must remain the primary residence of the ex-spouse; And
    • A non-occupying individual must not have nominated another property as their principal place of residence for the purpose of claiming permanent residence. This last requirement means that individuals will need to think carefully about the impact on the disposal of any other property that PPR relief may be associated with.

The above changes will be welcomed by private wealth advisors, including this firm, who have previously requested changes to these rules. No doubt divorcing couples would also be happy to have one less worry, that their joint assets will not be further depleted by CGT fees, during what can be a difficult period for all parties involved.


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