Divorcing couples – be aware of tax traps

Going through a divorce can be an emotional time with many new situations to navigate and decisions to be made. On top of the other financial considerations that need to be finalised, there are also some rather unexpected tax traps which could apply to couples that have been separated for a long period of time. Many couples are not aware that it is the moment of separation rather than the commencement of a divorce that can trigger tax consequences.

Best practice when it comes to money

When a couple reaches the decision to permanently separate, seeking early and specialist advice can enable a couple to ensure their financial separation is structured in the most tax efficient way possible and also prevents any unwanted surprises further down the line.

Alongside seeking early legal advice having the right financial advice will make sure that couples not only formalise and protect their financial positions with a court approved financial order, but will also make sure that they can navigate their separation and implementation of the financial agreement smoothly.

Capital Gains Tax (CGT)

The government introduced the Finance Bill 2022/23 which, if passed in its current form will come into force on 6 April 2023. This bill seeks to reduce the CGT burden at an already difficult time for divorcing couples.

The current rules

Transfers of assets between spouses do not usually give rise to CGT. This only applies when a divorcing couple transfers chargeable assets as part of their wider financial settlement during their tax year of separation. Timing is therefore absolutely key. If steps are taken to permanently separate at the beginning of a tax year, then a couple will still be able to transfer chargeable assets CGT free right up until the end of the tax year on the following 5 April. However if steps are taken to permanently separate towards the end of a tax year then the couple run the risk of not having enough time to utilise the potential tax savings.

Following the end of the tax year of separation any transfers between spouses will be deemed to be at market value.

The (potential) new rules

Unfortunately in many divorces the financial separation can take more than a year to resolve. Timing of separation is often a key factor in the financial remedy and can leave couples with little time to reach an agreement.

The Finance Bill 2022/23 goes some way to removing these issues. It is designed to extend the window of ‘no gain, no loss’ to three years (rather than maximum one year) after the end of the tax year of separation which gives considerably more breathing room for divorcing couples.

It also helps where there is a court order transferring assets between spouses. The ‘no gain, no loss’ treatment will apply even if the asset is transferred more than three years after the tax year of separation following the order.

Beware however. The bill does not remove the consideration of CGT for divorcing couples entirely and will still need to be considered as part of the overall net effect of any settlement. Any transfer will be taken at the acquisition cost, so if the value has increased then the party receiving the asset will inherit the gain (ie if the acquisition cost was £300,000 and the current value of the asset is £350,000 then the gain of £50,000 is inherited). This only matters when the asset is sold.

The bill goes even further and extends the availability of principle private residence relief. The party that moves out of the family home will not lose principle private residence relief where they have retained an interest and the property is sold to a third party, even if they have not occupied the property themselves since separation. Appropriate tax advice should be sought

There are important tax aspects to consider alongside a proposed financial settlement before steps are taken to document and implement any agreement. The tax implications arising on separation can be diverse and will likely depend on what assets are held and how they are going to be divided. As always seeking advice early on, if separating and divorcing, is invaluable to ensure assets are transferred as tax efficiently as possible.