Divorce and separation are never easy. There are many tricky decisions to make and aside from the emotional, financial and legal aspects, often overlooked but essential to consider, is the tax implications. While this may not be your top priority, understanding these implications is essential to avoid unexpected surprises and to plan effectively for the future.

In this article, we outline the key tax rules surrounding divorce and separation. Our aim is to help you avoid costly mistakes and ensure you make informed decisions during this tough period.

What are the tax implications of divorce?

Below is a summary of the main tax considerations.

Capital Gains Tax (CGT)

• Whilst married or in a civil partnership, transfers of assets between spouses or civil partners are tax-free under the “no gain, no loss” rule.
• Separating couples benefit from this relief for up to three tax years after separation.
• After this period, transfers of assets are taxed based on market value at the time of transfer.
• Any transfers made under a court-ordered divorce settlement are always exempt from CGT.

Income Tax

• Income tax is assessed individually and so is not influenced by marital status.
• However, income generated from transferred assets may affect tax brackets and cause new tax obligations.

Inheritance Tax (IHT)

• Gifts or transfer of assets between spouses or civil partners are exempt from Inheritance Tax.
• Following divorce, this exemption no longer applies, and financial gifts are treated as Potentially Exempt Transfers (PETs), subject to IHT if the donor dies within seven years.

Other considerations

• Pensions: Pension sharing orders may have tax implications, but the tax treatment depends upon the pension scheme
• Stamp Duty Land Tax (SDLT): Property transfers under a court-approved divorce settlement are generally exempt from SDLT, but further advice may be required for complex arrangements.

Capital Gains Tax (CGT) and divorce

Capital gains tax (CGT) is one of the most important taxes to consider during a divorce, especially when transferring or selling assets. Here’s what you need to know so you don’t get caught out.

No gain, no loss transfers

Transferring assets between spouses or civil partners is exempt from Capital Gains Tax under Section 58 of the Taxation of Chargeable Gains Act 1992 (TCGA). However, when separation occurs and cohabitation stops, the exemption window is limited to three tax years following separation.  Additionally, any transfers made under a divorce settlement remain exempt from CGT indefinitely.

Permanent Separation and Decree Absolute

The three-year CGT exemption period is initiated with a court declaration of permanent separation. If any transfers occur after the exemption period but before the Decree Absolute is issued, the parties are still considered ‘connected persons’. This means that the Capital Gains Tax liability is calculated based on the market value of the asset at the date of transfer rather than the actual amount paid (if any). However, once the Decree Absolute is issued, the parties are no longer deemed ‘connected’ and CGT is then calculated based on the actual sale proceeds rather than the market value.

Clogged losses

If a capital loss arises from a transfer to a “connected party” (such as a gift to an ex-spouse after the CGT exemption period has ended but before the Decree Absolute has been issued), this loss is deemed a “clogged loss”. Clogged losses can only be offset against other gains from transfers to the same individual, so this does limit their use.

Family home and Principal Private Residence (PPR) Relief

The family home is often the most valuable asset in a divorce. PPR relief can exempt gains on the family home from CGT if it has been the main residence.

When the home is sold to an unrelated buyer, the spouse staying in the property keeps full PPR relief, meaning no CGT is due. The departing spouse is also exempt if the sale happens within nine months of leaving, under Section 223 of the Taxation of Chargeable Gains Act 1992.

If the departing spouse does not elect another main residence, they can retain PPR relief through “deemed occupation” rules.

If the departing spouse transfers their share of the home to the remaining spouse as part of the settlement, the property is treated as their main residence until the transfer date, keeping the transfer exempt from CGT. Additionally, if the departing spouse retains an interest in future sale proceeds, they can claim the PPR relief available at the transfer date up to the sale date. However, gains after electing another main residence will be taxable.

Foreign Property and Assets

Divorcing couples with overseas assets should consider additional complexities, as these assets may also be subject to local taxes in the foreign jurisdiction. Furthermore, fluctuations in currency values can affect the calculation of gains or losses.

Income Tax and divorce

While Income Tax is assessed on an individual basis and is not directly affected by marital status, it can still play a role in divorce settlements.

Child Benefit

After a divorce, the High Income Child Benefit Charge applies only to the person receiving Child Benefit if their annual income exceeds £60,000.

Maintenance payments

Maintenance payments, whether received or paid, have no direct tax implications—they’re not deductible for the payer and aren’t taxable for the recipient.

Income from transferred assets

Income generated from assets transferred during a divorce, such as rental income or dividends, becomes taxable in the recipient’s name. For instance, assets such as bonds, shares, or interest-bearing bank accounts allocated during the divorce settlement will result in the recipient being taxed on any income generated from them.

Inheritance Tax (IHT) and divorce

Divorce and separation impact Inheritance Tax. It affects how assets are taxed and passed on, below are the key changes to consider.

Spouse exemptions

Transfers of assets between spouses or civil partners are exempt from IHT (even during the period of separation). However, once the Decree Absolute is issued, these exemptions no longer apply.

Post-Divorce Gifts

Gifts made to an ex-spouse after divorce are treated as Potentially Exempt Transfers (PETs). If the donor dies within seven years, the gifts may be subject to IHT. Taper relief reduces the tax liability if the donor survives for more than three years but less than seven.

Non-domiciled spouses

Transfers to a non-domiciled spouse are only exempt from IHT up to £325,000.

Wills and estate planning

Divorce can affect the terms of your will. It is therefore necessary to update wills as soon as possible to reflect changes in marital status and to ensure your estate is distributed to your intended beneficiaries.

What should you do? – Key tips

Start planning asset transfers strategically

• Use the three-year CGT relief window to your advantage.
• Time transfers to maximise available reliefs – transferring assets early can help you avoid CGT liabilities down the line.

Understand property rules

• Confirm eligibility for relief on the family home.
• Explore “deemed occupation” rules for departing spouses.

Review income and allowances

• Consider how transferred assets will affect taxable income and allowances in the future.
• Keep detailed records of financial arrangements.

Update wills and estate plans

• Ensure wills reflects new circumstances and wishes.
• Consider IHT implications of financial gifts post-divorce.

Seek professional advice early

• Consult a tax adviser early to avoid missed deadlines or costly mistakes.

How can Gerald Edelman help?

Divorce is never easy, but dealing with the tax implications associated with it does not have to be difficult. At Gerald Edelman, we offer tailored advice to help you with your personal situation.

Our services include:

• CGT planning: Minimising liabilities through strategic asset transfers.
• Income Tax advice: Helping you understand changes to your tax obligations.
• IHT planning: Advice on navigating IHT rules for settlements and gifts.
• Comprehensive tax support: Ensuring the divorce process is handled efficiently and professionally.

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.