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Exploration of Capital Gains Tax (CGT) in Divorce and Separation

By admin
16 Nov 2023
Manage Tax Risk

Capital Gains Tax (CGT) can come into play when assets are sold or disposed of at a value higher than its initial cost, following the deduction of any applicable enhancement, acquisition or disposal expenses. CGT rates currently stand at 10% or 20%, depending on the income tax bracket of the individual, with higher rates of 18% and 28% applying to specific gains on residential properties.

For couples married or in civil partnerships, the transfer of assets between them is exempt from CGT until separation. After separation, this exemption remains valid until the earlier of two events: (1) their divorce order or judicial separation, or (2) the last day of the third tax year after the tax year they stopped living together, usually before April 6th in the third year following the year of separation.

However, once assets become subject to a formal separation agreement or divorce order, an unlimited time frame is available for making a transfer to a former partner without incurring a gain or loss for CGT.

It is crucial for divorcing or separating couples to carefully plan the division of their assets and seek legal and tax advice to minimise the tax impact of their separation and preserve maximum value for equitable distribution.

Defining Separation for CGT Purposes:

Spouses or civil partners are considered separated for CGT purposes under various conditions:

Separation through a court order.

Separation via a formal Deed of Separation, typically sealed (except in Scotland, where witnessing is required).

In cases where they are genuinely separated with the expectation of permanence.

For CGT purposes, it’s important that the marriage or civil partnership has indeed broken down; otherwise, even if the couple no longer resides together, they are treated as living together.

Taxation of Divorce Settlements:

As previously mentioned, when spouses are not separated, assets can be transferred between them without incurring CGT. However, if they have separated, the CGT exemption remains valid until the end of the third tax year after separation or the date of the divorce or separation order. Once a formal separation agreement or divorce order is in place, there is no time limit for making a transfer to the former partner without triggering CGT.

For married couples, if the CGT exemption is no longer applicable due to separation, transfers between the separated couple are treated as transactions between ‘connected persons’ until the decree is absolute. This could result in transactions occurring at market value, potentially leading to CGT liabilities.

Transfers occurring after the decree absolute are typically on a no gain/no loss basis, unless there is undervaluing or outright gifting involved. In such cases, CGT is calculated based on the market value, and any gain is taxed accordingly. This highlights the importance of careful consideration regarding capital gains tax, especially when considering the transfer of the marital home during divorce.

CGT Implications of Separation:

As previously mentioned, separated individuals can transfer assets between them without CGT until the end of the third tax year following their separation, usually before April 5th of that year or the date of their divorce or separation order. Transfers after this period are exempt from CGT if they are covered by a formal separation agreement or divorce order. Otherwise, they may be treated as gifts and subject to CGT if the market value exceeds the purchase cost of the asset and any other allowable expenses. For the disposal or transfer of the main residence of the individuals, principal private residence relief may be applicable for the dates in which they occupied the property.

Payment Timing for CGT in Separation or Divorce:

CGT may be due if a marital asset is transferred to a third party or the other spouse after the third tax year following the year of separation or the date of the divorce or separation order. However, if the asset in question is the marital home, the transfer could be exempt from CGT.

For chargeable gains on residential property that are not exempt, reporting and payment deadlines differ. For disposals on or after October 27, 2021, CGT must be reported and paid within 60 days of the completion date. For other property disposals, the gain must be reported by December 31 in the year following the tax year in which the disposal occurred. This underscores the need for careful consideration when selling a house during divorce.

Non-UK Residents:

When a non-UK resident sells or disposes of a UK property, they are required to report the sale of this property to HMRC within 60 days (for disposals on or after October 27, 2021). A report is to be made even if there is no liability to UK CGT.

Marital Home Sale:

Prior to sale, if one spouse continues to reside in a jointly owned home after the other partner moves out, the share of the sale proceeds attributed to the remaining spouse may be exempt from CGT, provided it was their main residence for the entire period of ownership. However, a proportion of the other partner’s gain may be liable to CGT if the house is sold more than 9 months after their departure.

‘No Gain No Loss’ Treatment:

No gain/no loss disposals occur when an asset is transferred at a value resulting in neither a gain nor a loss for the transferor. For instance, transfers between spouses or civil partners while they are cohabiting are typically treated as no gain/no loss, with the transferee inheriting the transferor’s CGT base cost.

Deferred CGT in Divorce or Separation:

Relief is available when a leaving spouse or civil partner transfers their share of jointly owned property to someone other than the remaining spouse or civil partner before the property is sold. Conditions for this relief include a 9-month waiting period, continued use as the other spouse’s main residence, a transfer under a Consent Order, and a claim submitted to HMRC within 2 years of the Order being made. If these conditions are met, private residence relief from CGT remains applicable.

Relief is also accessible when the leaving spouse transfers their share of the jointly owned marital property to the remaining spouse, with the ‘initial disposal’ complying with a deferred sale agreement. When the remaining spouse eventually sells the property and pays the leaving spouse their share of the profit, it is treated as a gain from the initial disposal. This gain qualifies for private residence relief in proportion to the relief applied to the original disposal by the leaving spouse to the former spouse or, if applicable, in proportion to the private residence relief that would have been applicable without the no gain/no loss treatment.

In conclusion, divorce can be an emotionally taxing process, and it’s easy to overlook the financial implications, including CGT. Expert tax advice is crucial during divorce or separation, ensuring that individuals consider the potential tax consequences when making financial decisions. This advice is invaluable in safeguarding assets and achieving an equitable division, especially when creating pre- or post-nuptial agreements.

Getting divorced and have CGT concerns? speak to a member of the team  here 

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