17 December, 2018 / IN Tax and accounting
When your clients divorce, determining the value of the asset pool is a major consideration.
But have you considered the capital gains tax implications of a divorce settlement?
More often than not, assets received as part of property settlement will be capital assets, such as real property and shares. When ownership is transferred between parties, it normally attracts capital gains tax (CGT).
The potential future tax liability attached to the assets that your clients receive can be sizeable.
So how can CGT affect the split of the asset pool?
Divorce and capital gains tax: Key considerations
CGT relationship breakdown rollover relief
The good news is that, for many of the assets received under the property settlement, CGT relationship breakdown rollover relief will be granted.
The marriage CGT relationship breakdown rollover is dependent on various conditions being met.
The primary condition is that the asset is transferred under a court order or binding financial agreement.
If assets are transferred between the spouses without meeting this condition, the rollover relief is not granted and CGT will apply to the transfer of the assets.
Where the conditions have been met, the marriage breakdown rollover rules automatically apply and the CGT gain or loss arising from the transfer is disregarded. The cost base and tax status of the transferred asset is also preserved under the rules.
Main residence exemption
It is worth noting that, in most circumstances, a gain realised on the family home is exempt from taxation under the main residence exemption.
This should be taken into account when splitting the assets in a property settlement.
Example where capital gains tax affects a divorce settlement
To illustrate the importance of considering CGT during settlement negotiations, let’s take the example of Mr and Mrs Smith.
Together, they own their family home and a rental property, each costing $600,000 and valued at $1,000,000.
As a result of their divorce settlement, it is agreed that Mr Smith will retain the rental property and Mrs Smith will retain the family home. The transfer of the assets into each of their names is eligible for CGT relief, so no capital gains tax is paid.
Not an equal divorce settlement – because of capital gains tax
On the face of it, it seems that each spouse will walk away with assets worth $1,000,000.
However, should Mr and Mrs Smith then sell their respective properties, Mrs Smith will pay no capital gains tax as she holds the family home and it retains its tax-free status.
Unfortunately for Mr Smith, the investment property he holds will attract capital gains tax, which could be as much as $94,000 on a capital gain of $400,000.
So, while Mrs Smith does walk away with the expected $1,000,000, Mr Smith only benefits by $906,000.
Where CGT relief does not apply to the divorce settlement
It is critical to note that CGT relief does not extend to assets transferred to anyone other than the former spouse i.e. to a company or a trust.
In that case, capital gains tax will be payable by the spouse or entity transferring the asset.
If Mr Smith had directed that the rental property should be transferred to a family trust, the tax consequence of the above settlement would be significantly different again.
Does capital gains tax affect shares in a divorce settlement?
In the above example, we consider real property, divorce and capital gains tax.
However, the same rules would equally apply to shares in the family business in place of a rental property.
Achieve a divorce settlement with no surprises…
Capital gains tax is a complex area of tax legislation and its nuances are often overlooked by advisors, resulting in unintended settlement outcomes.
Our business valuation team have many years’ experience with navigating capital gains tax. We can work with legal advisors to identify issues and achieve a settlement with no nasty surprises.
Article by Tony Carter