Is Capital Gains Tax payable on divorce settlement?

Is Capital Gains Tax payable on divorce settlement?

There may well be tax implications on separation/divorce from a spouse or civil partner that you should be aware of.

The tax implications around Capital Gains Tax (CGT) on divorce changed in April 2023 in order to offer a fairer system for divorcing spouses/civil partners. These changes affect the rules on Capital Gains Tax on the transfer of assets as part of your separation or divorce settlement.

In this blog, I cover the things you need to know about Capital Gains Tax on a divorce settlement and other tax considerations during a divorce.

Let's start with the basics...

What is Capital Gains Tax?

Capital Gains Tax (CGT) can arise on the sale or disposal of an asset if the asset has increased in value and is higher than the original value of the asset.

You do not pay CGT when you sell or dispose of your main home. If you are married or in a civil partnership, you can transfer assets i.e., property/main residence, from one another without any CGT liability.

The rate you pay for capital gains tax depends on the level of your taxable income and the type of property being disposed of.

If you’re a basic rate taxpayer, the rate you pay depends on the size of your gain, your taxable income and whether your gain is from residential property or other assets.

If you’re a higher or additional rate taxpayer, you’ll pay:

• 28% on your gains from residential property
• 20% on your gains from other chargeable assets

Our accountants are experts in capital gains tax, get in touch to speak to them today.

Do I have to pay capital gains tax on my divorce settlement?

Historically, Capital Gains Tax general rules favoured married couples, offering tax-free transferral of assets between themselves and the ability to combine two individuals' CGT allowances in the disposal of a single asset. But when it came to divorce, the rules were very different.

As part of the Government’s Spring Budget, 15 March 2023, the Chancellor announced that the Finance Bill 2023 would contain legislation extending the period of time separating and divorcing spouses and civil partners can benefit from the CGT relief on transfers of assets between them.

The old CGT rules on divorce

There used to be a limited time period to transfer assets as part of a divorce settlement completely CGT-free within a financial year. Depending on the time of your divorce within a tax year and how long it took to conclude, this could leave individuals with a matter of months or weeks to conclude matters or face a hefty CGT bill, and many couples were caught in this CGT trap.

The new rules

From 6 April 2023 the rules changes regarding CGT on transferring assets between individuals going through separation or divorce.

The rules come into effect from the first day a couple stops living together and last until the end of the third financial year following the year of separation. During this three-year period, any transfers of assets will receive the ‘no gain, no loss’ treatment.

If your divorce extends beyond the three-year period, any asset covered by a written agreement as part of divorce settlements will also qualify for the same ‘no gain, no loss’ transfer, regardless of how much time has passed since the separation date.

There is also an option to claim Private Residence Relief (PRR) for a future sale of the former matrimonial home if they have maintained a financial interest in it following separation.

Whilst the rules changed from 6th April 2023 onwards, there is the ability for them to be applied retrospectively. Meaning if you separated two years ago but haven’t yet agreed on the division of assets or are separated and haven’t started divorce proceedings yet, there is still time to do so and benefit no Capital Gains Tax liability.

What does "No gain, no loss" mean?

Transfers of assets between spouses and civil partners who are living together are made on a “no gain or no loss” basis. This means that any gains or losses from the transfer are deferred until the assets are disposed of by the receiving spouse or civil partner, who was treated as having acquired the asset at the same original cost as the transferring spouse or civil partner.

Private Residence Relief (PRR)

The new rules benefit separating couples whose main asset is their home because of the option to claim PRR when the former matrimonial home is sold. The new rules and extended time limits mean that a departing spouse or civil partner, who has transferred their share to the remaining spouse or civil partner, will be able to make a no gain or no loss disposal.

Where the property is sold to a third party, further specific exemptions will increase the amount of PRR, enabling the departing spouse or civil partner to retain the same tax position as had they remained in the matrimonial home.

What assets can be transferred between spouses?

Assets include shares and investments, certain personal possessions and property.

How does HMRC determine the date of separation?

For Capital Gains Tax, you are deemed to have separated from one another if:

1. It is expressed in a Court Order;
2. It is expressed in a Separation Agreement; or
3. In such circumstances, the separation is likely to be permanent.

Are there other taxes to pay during divorce?

Inheritance Tax

Transfers between spouses are exempt from inheritance tax (IHT), and this continues throughout the period of separation up until the decree is absolute.

Income tax

Couples are taxed independently, and therefore divorce may not have an impact on an individual’s income tax position.

However, if you receive income generating assets as part of a divorce settlement, such as a second property you intend to rent out or shares that generate dividend income, then you need to declare this income on your self-assessment tax return.

Maintenance payments generally fall outside the UK tax system and so are not taxable on the recipient.

How can Haines Watts tax advisors help?

Tax rules continually change, and often a business owner and their spouse or civil partner will have complex tax situations and multiple assets to split during a divorce. Therefore, it is wise for both parties to seek advice from a tax professional.

Our tax team help many business owners navigate the complex area of separation and divorce to ensure all their tax liabilities are met and they minimise their tax bill.

Conclusion

These changes in the CGT rules on divorce mean that separating spouses and civil partners are less likely to have to pay Capital Gains Tax than previously, which is good news.

However, where there are several assets being transferred, such as multiple properties, overseas assets and company shares and the potential of some of these generating income, you should take advice regarding your overall tax position.

If you would like assistance with CGT tax planning, contact our team in Liverpool, Chester or Wirral.