Tax considerations for separation and divorce

There are many difficult and time-consuming decisions to be made throughout the process of separation and divorce. Many of these involve assets and tax, and there are a plethora of financial factors to consider when undertaking this course of action.

Capital Gains Tax

Capital Gains Tax (CGT) may be an alien legal concept for those embarking on the process of separation or divorce for the first time. This is a longstanding aspect of tax regulation. However, the guidance will change in the new tax year.

Section 58 of the Taxation of Chargeable Gains Act 1992 refers to the transfer of assets between people previously cohabiting with their spouse or civil partner. Under the current legislation, a ‘no gain, no loss’ treatment on transferred assets is available until the end of the tax year in which the instance of separation occurs. This ruling has often been deemed unfair due to the length of time that it might take for a couple to agree on a fair division of assets during a notably difficult and emotive time.

Therefore, from 6 April 2023, separating civil partners or spouses will be afforded up to three years, commencing from the year they cease cohabitation, in which they can make “no gain or no loss” transfers of assets between one another. This change in ruling means that chargeable assets such as property, business interests or shares can be transferred between those who separate without incurring CGT.

Overall, the updated measure is intended to make the rules surrounding CGT for separating or divorcing couples fairer. It is hoped that the additional time allowed for couples to distribute assets between themselves, before CGT charges are incurred, will alleviate the emotional and financial burden on individuals. Only those separating from a marriage or civil partnership are able to make use of the “no gain, no loss” provisions which will be in place, and this should be taken into consideration.

Permanent Separation and Decree Absolute

When a couple makes the decision to legally separate, a court order is produced to declare that they are in a state of ‘permanent separation.’ This triggers the aforementioned period in which CGT relief is granted. Until this period of relief expires, a couple is regarded as “connected persons” under the terms of CGT, despite having declared permanent separation. However, once the period culminates, a Decree Absolute is pronounced, and they are legally deemed as unconnected individuals.

Therefore, once the tax year of a separation has passed, or under the new rules, three years of separation have passed, asset transfers must be made at market value for the purposes of calculating the CGT due to be paid, rather than the amount originally paid for the assets.

For this reason, an initial transfer of assets in anticipation of separation should be considered by couples who are filing for divorce or separation.

The Family Home

Sale

As one of the largest investments many people make, the family home often represents a significant portion of a couple’s assets. The property, or the proceeds from selling it, often form an integral part of any divorce or separation settlement.

In an instance where the family home is to be sold, and the proceeds will be divided between the spouses or partners as per a settlement agreement, profits on the sale can be exempted from CGT in the hands of the spouse who remains living in the home at the date of its sale. In an instance where the sale of the property takes place within nine months of the departing spouse having left the family home, any capital gains here will also be exempt from CGT.

It is important to note that if the departing spouse has elected for another property to be treated as their main residence upon departure, any capital gain relating to the period following the election will be taxable, and the departing spouse will be liable for such costs.

Transferring the property to the occupying spouse

In some instances, a departing spouse holds sole ownership of the elected main residence, or co-owns the home with the occupying spouse, and subsequently transfers the home to the occupying spouse under the divorce settlement.

When situations such as this arise, it is possible for the departing spouse to claim that the residence should be regarded as their ongoing main residence from the date they left it, right up until the date it is eventually transferred to the remaining spouse.

In scenarios where this claim is upheld, the transfer to the occupying spouse is exempt from CGT.

Non-UK property

In instances where the separating couple co-own foreign assets; property, for example, which are set to be transferred as part of a settlement, then the impact of fluctuations in the value of foreign currency on the capital gains must be considered.

The purchase price of a property and its value upon disposal will be calculated according to sterling rates on the relevant dates on which the separation and sale take place. This methodology can sometimes produce perplexing results. For example, a property’s value may have decreased in terms of the local currency but have increased in terms of sterling rates as a result of currency movements. Couples seeking divorce must bear this taxation intricacy in mind.

In addition to these considerations, there are likely to be sticking points regarding local taxation on the transfer of foreign property under a divorce settlement, even if you are a British national.

Income Tax

Despite being legally connected, spouses and partners are each taxed independently on income they receive in the tax year. This convention continues during the period of separation and after the Decree Absolute is filed. In terms of income tax, individuals are treated as unmarried upon the date of permanent separation.

The transfer of any shared assets under a divorce or separation settlement is, of course, not subject to income tax. However, it is important to note that if one-half of the couple is allocated assets which generate income over time as part of a divorce settlement; bonds, shares or bank accounts which gather interest for example, they will be subject to tax on any income which is subsequently yielded from the assets they receive as part of owning these assets.

Inheritance Tax

Transference of assets between former spouses or civil partners are exempt from Inheritance Tax. This convention remains the case throughout the period of separation, up until Decree Absolute is legally pronounced.

However, the tax exemption has an upper limit. A lifetime total of £325,000 is the maximum sum which can be transferred tax-free if a transfer is being made from a UK-domiciled spouse to a non-domiciled spouse. Currently, no limit is imposed on the exemption for transfers from a non-UK domiciled spouse to a UK-domiciled spouse, nor in an instance where both spouses are non-domiciled.

How can Gerald Edelman help?

If you would like further advice on a divorce or separation process and the potential tax implications, contact our team today who would be happy to discuss your situation.